Over the last two years, the 105% advance in the S&P 500 recovered 697 points of the 909 points lost between October 2007 and March 2009. In percentage terms, the S&P 500 so far has recovered 77% of the 909 slide.
Comparably, the NYSE Composite recovered 73% of its bear market drop. A few indices have done even better. The Dow Jones Transports, the Russell 2000, and the NASDAQ Composite ended April 2011 a fraction of a percent above their 2007 bull market highs. However, the NASDAQ still remains 45% below its 2000 all-time high.
The amazing recovery from the March 2009 abyss, in recent days, made believers out of even high-profile bears such as Dow Theory Letters’ Richard Russell and Canada’s David Rosenberg. Abandoning a long-held market view must not be only humbling, but also may diminish one’s professional reputation. Furthermore, switching to 100% long as the market indices are closing in on their all time highs runs the risk of tangible financial losses.
In spite of the extraordinary two-year equity rally, major stock market averages have gained little ground over the last 10 years. Instead, the last decade has belonged to commodities, with silver, gold, copper and crude advancing by 1,014%, 488%, 437% and 302%, respectively.
A graph of the S&P 500 and gold bullion over the last 20 years reveals that, since 2001/2002, their historical inverse correlation has undergone a complete reversal. The prices of both the S&P 500 and gold bullion rallied strongly within the 2002–2008 time frame. Following the large decline in 2008/2009, both have been on a tear ever since.
The big question is: how long can this idyllic investment environment, sustained by the tsunami of new money unleashed by the Fed, last?
If history can still be relied upon as a guide, inevitably higher inflation will prove detrimental to stocks and favor even higher prices for hard money assets.
Even before the official inflation rate starts to weigh on financial markets, they will be severely tested when the Fed completes its $600-billion QE2 at the end of next month. The U.S. government still finances its huge deficit by additional borrowing. There are no obvious buyers to step in when the Fed halts its massive buying of treasuries.
The odds that “Sell in May and Go Away” will pay off are very favorable this year.