Don't let the recent stock market rally fool you, says Chicago options trader Todd Horwitz. The chief strategist at BubbaTrading.com says it's all part of a carefully crafted feat of financial engineering by the world's central banks.
"All the central banks are trying to pump in liquidity. China owns about 60 per cent of their market and every major economy is buying up their own stock markets," he says, pointing out that it was the promise of more stimulus from the Bank of Japan that actually helped spark the July rally.
Beneath the jubilation, he says, lurks a false economy fuelled by newly printed money masking real economic growth. "The only growth in this market is companies buying back their stock," he says. "No major company in the U.S. is putting any real money into capital expenditures."
After floundering for more than a year, the benchmark S&P 500 only recently topped its all-time high, prompting concerns from Mr. Horwitz and others that markets could be heading into another Cold War era, where prices traded in a flat range for nearly two decades before 1980.
Today, the bottom of a narrow trading range is supported by the conviction that central banks will keep interest rates low and continue supplying cheap cash to support minimal growth, Mr. Horwitz says. The top of the range, he says, is capped by the conviction there is no real economic growth in the world and little potential for big corporate profits.
"Overall markets don't have the ability to want to go higher or lower because you have nothing real going on," he says. "You have a rigged, controlled environment."
He expects the stagnation to last as long as central banks keep interest rates low. Central bank benchmark rates remain near zero – some below zero – since they were slashed as an emergency measure in the wake of the 2008 global financial crisis.
About a quarter of the global bond market now has negative yields, says Joey Mack, the Toronto-based director of fixed income at GMP Securities. "It's unprecedented where we are today. … It's very much a market that is being manipulated by central banks to try to stoke growth," he says.
For insight into where the global economy might be heading, Mr. Mack looks to Japan, where the economy has been stagnant for more than 20 years. "You have an aging population and you don't have a lot of growth. Government spending is turning more and more to health care and senior spending."
Europe is showing the same symptoms of "Japanification," he says. With The U.S. Federal Reserve holding off on a rate increase, and expectations for further stimulus from the Bank of Japan and the Bank of England in the wake of the Brexit vote, he says there is little to suggest the trend will end. "It can go on for a very long time," he says. "I suspect that monetary policy has reached its limits, though."
Not everyone buys the Cold War market theory, however.
"Comparing markets during the fifties, sixties and seventies to the 2000s is like comparing professional sports in the same time frames," says Art Hogan, chief market strategist at Boston-based Wunderlich Securities Inc. "We live with a faster pace of change. We are in a global economy and we are all more connected. Disruptive technologies are popping up weekly."
Mr. Hogan expects low stock prices and decent corporate earnings to drive the value of the S&P 500 more than 10 per cent higher in the next year. "We have an inflection point in earnings, stability in both energy prices and the U.S. dollar. We have an under-loved and under-invested bull market."
He sees the most growth potential in technology-related subsectors including social media, online travel, biotech, mobile communications and e-commerce.
Greg Newman, director and portfolio manager at Toronto-based Scotia Wealth Management, shares Mr. Hogan's view that stocks are poised to go higher – to a point. "I'm alert to the possibility that we could be in flat markets. We have extremely low interest rates and not a lot of global growth," he says.
To hedge against flat markets, Mr. Newman gives priority to stocks that pay dividends and options that generate income.
"You can really squeak out more yield both ways if we are in a flattish environment," Mr. Newman says. "You're getting dividends, but you're also getting premiums through options."
Dividend-paying blue-chip stocks, such as the big Canadian banks, pay out consistent annual yields much higher than bonds no matter what price the stock is trading at.
Options strategies, such as selling or writing covered calls, allow a shareholder to also collect a premium in exchange for giving a buyer the right to buy a stock if its price rises. If the stock goes up by a certain date, the shareholder must sell at the agreed-upon lower price, but he or she still pockets the premium and dividend. If the stock trades flat or falls when that date comes, the shareholder keeps the stock, the premium and the dividend. This strategy isn't for casual investors, however.
"The Dow and TSX can stay the same 12 months out and you can earn a 3- or 4-per-cent dividend, plus another 4 or 5 per cent from premiums by actively selling calls," he says.
The options market, like the bond market, can also provide insight into where the stock market is heading. Mr. Newman says options premiums are relatively high now, which signals that investors believe equity markets will go higher.
"If the market believed there would be no growth," he says, "there would be very little options premium."