`Suckers' Rally' Signaled After S&P 500 April Surge (Update1)
By Michael Tsang and Nick Baker
May 5 (Bloomberg) -- The biggest rally in the Standard & Poor's 500 Index in more than four years is luring investors to equities from cash, just as options traders are betting the advance will evaporate.
The benchmark index for American shares rose 4.8 percent in April, the steepest jump since December 2003, and has climbed 11 percent from a 19-month low in March. The rebound came as Federal Reserve Chairman Ben S. Bernanke arranged the bailout of Bear Stearns Cos., took subprime-tainted mortgages as collateral from investment banks and cut borrowing costs to a three-year low.
Jean-Marie Eveillard, who runs the $22 billion First Eagle Global Fund, is skeptical the gains can last because the worst housing slump since the Great Depression will reduce earnings. S&P 500 companies are valued at 22.7 times profit, the most in four years. Options traders are paying 63 percent more to protect against a drop in the S&P 500 than to bet on a gain, the widest difference since at least 2005.
``It may be a suckers' rally,'' said Eveillard, who is based in New York. ``Investors want to believe. But if I'm right, then there's truth to the argument that this is the worst financial crisis since the end of World War II. The same kind of reflex is the wrong reflex.''
The S&P 500 gained 1.2 percent to 1,413.90 last week, adding to the rally that helped the measure avert a bear-market collapse of 20 percent. The benchmark index plunged 18.6 percent from its record 1,565.15 on Oct. 9 to its low on March 10.
Futures on the S&P 500 today lost 0.4 percent to 1,409.8 at 8:57 a.m. in Frankfurt.
Cash to Equities
As the advance took hold last month, investors shifted more than $100 billion out of cash held in money market funds, whose assets had swelled to a record $3.54 trillion, according to data compiled by Washington-based Investment Company Institute.
The climb hasn't dispelled concern among traders of U.S. options. Implied volatility, the measure that calculates expected price swings of an underlying asset and is used as a barometer of options prices, shows that many investors are betting the U.S. stock market will falter.
The implied volatility on options that lock in gains if the S&P 500 drops at least 10 percent in three months reached 24.67 on April 30, Bloomberg data show. That compared with 15.1 for options that pay out if the index rises at least 10 percent.
The 63 percent difference indicates the highest demand for options insurance since at least 2005, according to data compiled by Bloomberg. A decline of 10 percent from the S&P 500's closing price last week would take the measure down to 1,272.51, below its March 10 low of 1,273.37.
Sucker Protection
``There are pockets in the marketplace that believe this is a sucker rally, and they're willing to pay a substantial premium for downside protection,'' said Robert Arnott, whose Pasadena, California-based Research Affiliates LLC oversees $26 billion. He said in December 2006 that a bear market was probable.
Nouriel Roubini, professor of economics and international business at New York University's Stern School of Business, says the Fed's seven rate cuts since September -- which lowered the benchmark lending rate to 2 percent from 5.25 percent -- aren't enough to stave off a contraction and that earnings expectations are unrealistic.
Investors are currently paying the highest prices relative to earnings since March 2004 and 15 percent more than when the S&P 500 reached its all-time high in October.
The U.S. economy expanded 0.6 percent from October through March for the slowest six months since the 2001 recession. Meanwhile, consumer spending rose at a 1 percent annual pace last quarter, also the weakest since 2001.
Profit Rebound
Still, analysts estimate profits at S&P 500 companies will rise 12.1 percent and 51.7 percent in the final two quarters of 2008, respectively. For the first quarter, 363 companies in the S&P 500 have reported results, posting an average decline of 13.3 percent. That compares with analysts' projection at the start of the year for a 4.7 percent gain in the quarter.
``You're going to have further losses for the financial system and weakening of demand of employment, of earnings, of profitability that's going to push further down the stock market,'' said Roubini, who more than a year ago predicted a housing slump would drag the U.S. into a recession. ``This is a temporary, bear-market rally.''
ISI Group Inc.'s Jeffrey de Graaf, the top-ranked technical market analyst in Institutional Investor magazine's survey the last three years, says the decline in trading last month also shows investors aren't confident the gains will last. De Graaf is based in New York.
An average of 1.31 billion shares changed hands each day on the New York Stock Exchange, the least since September 2004 and the slowest for the month of April in six years.
Worst Is Over
Quincy Krosby, chief investment strategist at the Hartford in Hartford, Connecticut, which manages $360 billion, is more sanguine. She says the worst may be over for the economy and the financial markets saddled with $319 billion of bank losses.
Financial stocks in the S&P 500 have gained 11 percent since the end of March, the biggest increase among the 10 industries in the index. Meanwhile, gains in railroads, trucking companies and airlines signal the broader economy is growing and bolster the case that the stock gains are justified, Krosby said.
``It's a validation of investor belief the U.S. economy will pick up in the next six to seven months,'' she said. ``It's a sign the market is looking ahead past the downturn. Slowly but surely, the Fed rate cuts will be working their way into the economy.''
NYU's Roubini says that is a mistake.
There is ``complacency among investors thinking that the worst is behind us for credit markets and for financial markets and for the real economy,'' the New York-based Roubini said. ``This is not the year to be in risky assets like equities.''
bloomberg.com
(Interestingly, the article has since been yanked from the Bloomberg Headlines!) |
