Over the past three years we have been beaten over the head with the concept of flight to quality; simply as the equity market falls the bond market rallies. Global unrest crushes equities, the warm fuzzy blanket of Quantitative Easing rallies equities. Now I present to you the idea of equity flight to quality. Huh? Yes, flight to equities for safety.
Here is the theory. If I’m a global fund manager, especially in Europe, I’ve seen my local stock markets get crushed so I need to find somewhere to put my money. I don’t trust European bonds, I don’t trust European stocks. Precious metals are volatile especially if based on the wrong currency. So I look across the pond and see US Treasuries and US equities. US Treasuries are offering record low yields; the 10 year just fell to 1.5% and that just doesn’t look very appealing. This leaves US stocks.
Or we can look at the bullish equity case another way. Say you were trapped on an island for the last year and just returned home. Then I told you this: Treasury yields are at an all time low, the Euro is about to become a piece of history, several European nations are borderline insolvent, unemployment in America has hardly improved, the most anticipated IPO of a decade failed miserably, and JP Morgan just suffered a $2 billion trading loss a la Bear Sterns. What would you guess for the price of the S&P? 1,000? 900? 800? Even lower?
My point is this, the sky is falling, all hell is breaking loose, and CNBC is insanely negative. This has led to the S&P 500 collapsing to the point of 1,300…a mild 38.2% retrace of its October to April run. Not exactly the Armageddon that should have happened.
Lastly, it appears that 2012 is 2011 all over again. I’ve highlighted the way the market based last June; its looks very similar to what the market is doing right now. Big first quarter run up, hard selloff, rip your face off rally. I can see a sharp rally from here, and yes, I know that is a highly unpopular opinion.