The Stock Market Rally and the Election
The S&P 500 peaked in 1999 and has been in a secular bear market since then. It has experienced periodic cyclical bull markets since that point. After 9/11, we experienced a cyclical bull market driven by an injection of Fed liquidity. However, more liquidity injections were required until a new cyclical bull market began in 2003 driven by the rise of the shadow banking system. This was a multiyear cyclical bull that last until the subprime crisis of 2007.
Quantitative Easing and Cyclical Bull Markets
During the last several years, we have experienced short cyclical bull markets driven by quantitative easing. We find that the fallies coincide well with quantitative easing programs.
We also find that the recent rally seems to have begun with Fed programs last year, such as "Operation Twist," to infuse liquidity into the system.
At the time, many pundits were saying that the central banks and the governments were powerless to stop the downward spiral due to financial crisis in Europe. Bearish sentiment was rising to elevated levels. Then, just as it appeared the markets were going to crash, coordinated central bank intervention was announced.
The Federal Reserve, the European Central Bank, the Bank of England, the Swiss National Bank, the Bank of Canada and the Bank of Japan announced "coordinated actions to enhance their capacity to provide liquidity to the global financial system... These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points." Separately, the Bank of China eased as well.
The length of this cyclical bull market may be dependent upon whether the recent Fed actions represent the beginning of QE3. No one may actually call it by this name. However, the effects may still be the same.
Threats Still Remain
Problems in Europe still remain. There has been no real solution to the crisis. There is still also a real danger that a country such as Greece could decide to abandon the euro. This could cause a severe dislocation in the worldwide banking system.
The Arab Spring continues to be an Islamic Winter. There is a real possibility of a radical Islamic government in Egypt, and questions about abrogating its current peace treaty with Israel. The current military government will not allow this to happen. There is a possibility of a civil war in Egypt.