With all eyes clearly focused on the tragic events in Japan and the unrest/violence/burgeoning war in the Middle East/North Africa (MENA) region, investors didn’t have much time to celebrate the current bull market’s second birthday on March 10th. In fact, the Dow’s 228 point dive that day did not appear to be in the least bit festive, and then the earthquake and tsunami hit Japan the very next day.
But with the news flow seeming to take a back seat – at least for the moment – we are reminded that the stock market will eventually return to the macro fundamentals; namely earnings and the economy. Thus, we thought it might be a good idea to take a look at what history can tell us about what the third year of bull markets look like.
The analysts at Ned Davis Research tell us that there have been 35 bull markets since 1900 and that the current run for the roses ranks 15th in terms of duration. As such, the bulls may be correct in arguing that there is still some room to run on the upside – assuming, of course, that the current “shocks” don’t have a lasting impact on the economy, earnings, or the psyche of the consumer.
However, we should keep in mind that, as we’ve pointed out many times over the past couple of years, we see the current bull market as a cyclical or “mini bull” that is occurring within the context of the long-term bear cycle that began in 2000.
When looking only at the “mini bulls” that have taken place within a long-term bear environment, the situation changes a fair amount as the current bull run ranks 4th out of nineteen in terms of length. So, while there have been other bulls that have lasted longer, it is fairly important to note that this one sits at the longer end of the spectrum.
Looking at the cycle in terms of percentage gain, the Dow’s gain of +89.26% (as of February 18th) represents 12th out of all bull market advances. So, again, although this bull has indeed been impressive, it has not been unprecedented. And when you consider that the preceding bear was one of the most devastating in history, it is easy to argue that this bull should go a little farther than the historical average.
Looking ahead, NDR notes that of the fourteen bull markets that made it into their third year, 50% of them went on to celebrate a third birthday. And during what analysts deem the modern era (post World War II), five of the nine bull markets made it to a fourth year.
Another way to look at this data is that there is at least a 50% chance that the current bull will end before March 9th of next year. Or put in a more bearish bent, there is a 50% chance that a bear market will begin in the next eleven months.
On that note, don’t forget that our cycles indicate that we are due for a serious downturn later in the year and that this decline could easily wind up qualifying as a bear market (generally defined as a drop of -20% or more in the S&P 500).
What could cause such a downward move? Given that the current economic rebound has been less than robust and that job growth has been largely nonexistent so far, anything causing the economy to slow could easily cause stocks to falter – especially if valuations become stretched before then.
Another concern would be rising interest rates and/or inflation. And with companies such as Nike and P&G telling us last week that they are experiencing big increases in costs and that they will soon be passing along those costs to consumers, this is not a situation that investors should blindly ignore.
Granted, commodity inflation is not a huge problem within the calculation of CPI. The bottom line is there needs to be significant wage inflation in order to get the CPI moving higher in earnest. And in light of the fact that there is still a great deal of slack in terms of the jobs market, it is hard to see how wage inflation is going to be a problem anytime soon.
The point of this report is not to scare investors out of positions or to encourage anyone to take defensive action in the near term. No, the key is to recognize where we are within the cycle from an historical perspective and to understand that trees don’t grow to the sky forever.
So, if the bulls are able to overcome the current news environment, it is fairly easy to argue that stocks can head higher. Heck most of Wall Street believes the S&P will be up double digits this year. But at the same time, we are going to remind ourselves on a weekly basis that the next big move could easily be down.
