The stock market is getting a little scary.\u00a0 Having climbed the proverbial \u201cwall of worry,\u201d will it fall off the cliff of complacency?\u00a0 The short answer is definitely yes — but probably not for a few years, if not longer.<\/p>\n
Signs of complacency abound.\u00a0 CNBC\u2019s Joe Kernan notes that a few months ago many strategists were telling investors to \u201cwait for a pullback,\u201d but now you seldom hear that.\u00a0 The parabolic rise of \u201cglamour stocks\u201d like TSLA, NFLX and LNKD is a sure sign of a toppy market. \u00a0Yesterday\u2019s Wall Street Journal<\/i> is a cacophony of complacency.\u00a0 On page A-1:\u00a0 \u201cStocks Regain Broad Appeal: Mom-and-Pop Investors Are Back, but Some Say That Could Be Cause for Concern.\u201d\u00a0 On page C-1:\u00a0 \u201cNew-Issue Flurry Hints at Trouble\u201d and \u2013 even more alarming \u2013 \u201c\u2018Long-Only\u2019 Funds Trim Their Hedge.\u201d\u00a0 (What would you expect after the hedgies missed the first 120% of the bull run?)<\/p>\n
So how worried should we be?\u00a0 To put this bull market in historical context, we looked at the quarterly price of the S&P 500 since World War II to identify major bull and bear markets.\u00a0 This is an inexact process; others would slice and dice the data differently.\u00a0 See the Appendix for my chronological analysis.\u00a0 Two conclusions:<\/p>\n
Lags and Lurches<\/b><\/p>\n
Since the 19th<\/sup> century the stock market has alternated between lags and lurches \u2013 that is, between lengthy periods when stocks \u201cdo nothing\u201d<\/b> (1907 -1920, 1929-49, 1972-82, 2000-2011) and \u201csecular bull markets\u201d<\/b> when stocks surge (1920s, 1949-72, 1982-2000).<\/p>\n Below I dissect the secular bull markets of 1949-72 and 1982-2000, but first we\u2019ll outline a template of how the typical secular bull market evolves over time.<\/p>\n The Three Stages of a Secular Bull Market<\/b><\/p>\n At the start of Stage I<\/b>, which follows many years of poor performance for equities, most investors hate stocks because they are \u201ctoo risky.\u201d \u00a0Even when stocks post strong gains there is disbelief that the bull market is \u201cfor real.\u201d\u00a0 (Sound familiar?)\u00a0 For example, in 1954 Congress held hearings on the dangers of stock market speculation because the S&P 500 had finally exceeded its 1929 high.\u00a0 In Stage I the upward move in stock prices is fairly smooth and strong as investors belatedly move back into stocks from other assets such as bonds, cash, commodities and (in the current cycle) hedge funds.\u00a0 In Stage II<\/b>, after the \u201ceasy money\u201d has been made stocks becomes more volatile and risky for various reasons \u2013 they are more expensive, the Fed is starting to tighten, and the risk of recession is higher.\u00a0 Stage III<\/b> is characterized by a speculative blow-off as dumb money embraces a \u201ccult of equities\u201d and buys overpriced stocks on margin while regulators stand idly by, afraid to break up a great party that is pouring capital gains tax revenue into the U.S. Treasury.<\/p>\n We Are Still in Stage I of a New Secular Bull Market<\/b><\/p>\n Since March 30, 2009 the S&P 500 has climbed 122%.\u00a0 That sounds like a huge gain, but it is not that big compared to history.\u00a0 In Stage I of the 1949-72 secular bull market, stocks climbed 235%, and in Stage I of the 1982-2000 secular bull market they rose 190%.\u00a0 <\/b>Also, in Stage III of the latter bull market\u2014i.e., the 1990s–stocks rose 390%; even if they had stopped in Dec. 1996 when Alan Greenspan lamented \u201cirrational exuberance\u201d the gain would have been 142%.<\/p>\n Stocks probably won\u2019t keep going \u201cstraight up\u201d as they did this year.\u00a0 But keep in mind that, even if the Fed starts tapering soon, the yield on money funds will be close to zero for the next couple of years; by contrast, the yield of the S&P 500 \u2013 using the current price and estimated 2014 dividends \u2013 is 2.4%.\u00a0 Endowments and institutions that have been eschewing equities for years will lumber back into stocks.\u00a0 Though profit margins won\u2019t rise much from current levels, profits can grind higher as the global economy improves.\u00a0 Another positive that Wall Street has ignored is that U.S. economic policy is likely to improve markedly once Obama is replaced by a less socialistic President.<\/p>\n One big risk is a melt-up.\u00a0 As we have noted before, Obamacare and other regulations are impeding hiring, which remains weak even though other economic indicators (such as ISM\u2019s) are improving markedly.\u00a0 With the Fed focused on employment despite these regulatory headwinds, it could remain too loose for too long, creating a stock market bubble and then a crash.\u00a0 But it\u2019s a little hard to believe the Fed is that stupid after missing both the tech and housing bubbles.\u00a0 But anything is possible in the city that produced Obamacare.<\/p>\n Anatomy of the Secular Bull Market of 1949-72<\/b><\/p>\n Stage I\u00a0 Q2 1949 to Q1 1957<\/b>\u00a0 Stocks rise fairly smoothly, from very low valuations, as the U.S. economy expands and the much-feared return of the Great Depression does not happen.\u00a0 In this period recessions were shallow and inflation low.\u00a0 Nevertheless, individual investors gravitated toward stocks as a \u201chedge against inflation.\u201d Market rises for 33 quarters, up 235%.<\/p>\n Stage II\u00a0 Q2 1958 to Q2 1966<\/b>\u00a0 Market becomes much more choppy.\u00a0 It declines 15.6% in the 1957 recession, then surges for four years to decidedly lofty valuations, before a severe sell-off in the spring of 1962.\u00a0 It then rises 69% before Fed tightening causes a recession scare in 1966.<\/p>\n Stage III Q3 1966 to Q4 1972<\/b>\u00a0 \u00a0The bull market became quite speculative, with lots of excitement about high-tech stocks, diversified \u201cconglomerates,\u201d (a truly dumb corporate innovation from the decade that brought us the Vietnam War) and, in 1972, the \u201cnifty fifty\u201d \u201cone decision growth stocks\u201d such as McDonalds, Pfizer, Disney etc.\u00a0 The party ended sadly in 1973 when inflation soared and the \u201cArab Oil Embargo\u201d started in the autumn of that year.<\/p>\n Anatomy of the Secular Bull Market of 1982-2000<\/b><\/p>\n Stage I\u00a0\u00a0 Q2 1982 to Q3 1987<\/b>\u00a0 Stocks surge as inflation and interest rates decline.\u00a0 Individuals remain skeptical and can afford to do so because real interest rates offered by bonds and money market funds remain high.\u00a0 \u00a0Market rises for 22 quarters, up 190%.<\/p>\n Stage 2\u00a0 \u00a0Q4 1987 to Q3 1990<\/b>.\u00a0 Stocks become much more volatile.\u00a0 They decline 30% in the 1987 crash, rise 45% between Q4 1987 and Q2 1990, then decline 14.5% in the 1990-91 recession brought on by Saddam Hussein\u2019s invasion of Kuwait.<\/p>\n Stage 3\u00a0\u00a0 Q3 1990 to Q1 2000<\/b> \u00a0Over 39 quarters the market rises 390%.\u00a0 This phase started slow because of a \u201cjobless recovery\u201d from the 1990-91 recession.\u00a0 But stocks surged in the second half of the decade, with five straight years of 20%+ gains (1995-99) as productivity growth picked up, GDP accelerated, and investors embraced \u201cnew economy\u201d Internet stocks.\u00a0 All was not rosy.\u00a0 The 1997-98 Asian Financial Crisis raised the specter of global deflation and caused a U.S. financial panic in the autumn of 1998. \u00a0The Fed eased in response to both the Asian financial crisis and the risk to IT systems posed \u201cY2K.\u201d This liquidity fueled the final speculative surge in 1999-2000, which Greenspan did little to discourage via higher margin requirements.<\/p>\n \u00a0<\/b><\/p>\n Appendix: Stock Market History since 1949 (based on quarter-end prices) <\/b><\/p>\n Q2 1949 to Q1 1957<\/b>\u00a0\u00a0 Secular bull market begins<\/span>; market rises for 33 quarters, up 235%.<\/p>\n Then market drops 15.6% in a pretty severe recession in 1957.<\/p>\n Q4 1957 to Q4 1961<\/b>\u00a0\u00a0 A post-recession surge.\u00a0 Market rises for 17 quarters, up 79%.<\/p>\n Then market plunges 23.5% because of over-valuation in first half of 1962<\/p>\n Q2 1962 to Q4 1965<\/b>.\u00a0\u00a0\u00a0 Market rises for 5 quarters, up 69%.<\/p>\n Market drops 17% in 1966 on Fed tightening, recession fear<\/p>\n Q3 1966 to Q4 1968<\/b>.\u00a0\u00a0 Market rises for 10 quarters, up 36%.<\/p>\n Market drops 30% in 1969 malaise and 1970 recession<\/p>\n Q2 1970 to Q4 1972<\/b>.\u00a0 Market rises 11 quarters, up 62% as economy recovers from recession. Nifty fifty blow-off in 1972.<\/p>\n Market drops 46% in 1973-74 on severe inflation, \u201cArab oil embargo,\u201d and recession–a disaster for financial assets, particularly growth stocks, such as the \u201cnifty fifty.\u201d<\/p>\n Q3 1974 to Q4 1976<\/b>\u00a0\u00a0 Market rises 10 quarters, up 69%<\/p>\n Choppy market and then back to back recessions (1980 and 1981-82); market does little for five years.<\/p>\n <\/p>\n Q2 1982 to Q3 1987<\/b>\u00a0\u00a0 New secular bull market begins<\/span>.\u00a0 Market rises for 22 quarters, up 190%, on disinflation, rising PEs and profits.<\/p>\n Then, market crash in autumn of 1987 on fears of Fed tightening, plunging dollar; market down 23%<\/p>\n Q4 1987 to Q2 1990<\/b>\u00a0 Market rises 11 quarters, up 45% as economy remains fairly strong despite stock market crash.<\/p>\n Then, recession in 1990-91; market falls 14.5%<\/p>\n Q3 1990 to Q1 2000<\/b> stocks rise 39 quarters, up 390%, amidst strong economic growth and tech bubble.\u00a0 Brief plunge in 1998 Asian crisis but recovery as Fed eases policy.<\/p>\n Severe bear market after tech bubble; stocks down 45.6%<\/p>\n Q3 2002 to Q3 2007<\/b>\u00a0 stocks rise 21 quarters up 87%<\/p>\n Financial crisis; stocks decline 47.7%<\/p>\n <\/p>\n Q1 2009 to Q3 2013<\/b>\u00a0\u00a0 New secular bull market begins<\/span>.\u00a0 Stocks rise 19 quarters up 120% as economy recovers, short term interest rates go to zero.<\/p>\n Copyright Thomas Doerflinger 2013.\u00a0 All Rights Reserved.<\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" The stock market is getting a little scary.\u00a0 Having climbed the proverbial \u201cwall of worry,\u201d will it fall off the cliff of complacency?\u00a0 The short answer is definitely yes — but probably not for a few years, if not longer. … Continue reading