Stocks are now well into the fifth year of what has been one of the longest bull markets in history.
Stocks are an image of beauty, and it seems as though the fun is never going to end.
Except it always does, and the longer the festival rolls on, the longer and more daunting the clean up process will be for investors in the aftermath.
It does not get much better than today. Stocks are now well into the fifth year of what has been one of the longest bull markets in history. And they continue to make a charge toward fresh new highs seemingly with each passing day. Although economic and corporate fundamentals have not been meaningfully supportive of sustainably rising stock prices for more than two years, the ongoing support of stimulus from the U.S. Federal Reserve have kept stocks on a steady upward trajectory. Stocks are an image of beauty, and it seems as though the fun is never going to end. Except it always does, and the longer the festival rolls on, the longer and more daunting the clean up process will be for investors in the aftermath.
It is difficult to imagine how things could possibly be anything other than wonderful for investors when looking at the U.S. stock market today. Stocks as measured by the S&P 500 Index (SPY) paint a striking picture of a market that is rising to the sky with layers of strong technical support. This includes a well tested upward sloping trend line that currently comes into play at around the 1850 level and its upward sloping 200-day moving average currently at 1790 that the S&P 500 has not even taken a whiff at since late 2012. Delightful indeed!
Of course, the stock market has painted portraits of strikingly similar beauty in the past. Unfortunately, they eventually led to a tragic ending.
Let us stroll through our gallery to take a look.
Our next collection starts with a portrait showing the stock market from January 2006 to October 2007.
The stock market was also in the fifth year of a bull market following the bursting of the tech bubble. And through July 2007, it was difficult to even perceive when looking at the markets that anything could possibly go wrong. And even after what was a brief and long overdue correction in August 2007, stocks quickly bounced back to carve out new highs. No matter that corporate earnings growth was slowing and that banks were dealing with some troubled mortgage loans. For as long as the Fed was providing support in the form of lower interest rates, all would be well.
The following are some quotes following the market close on October 9, 2007, which was the day when the market reached its peak for the bull market cycle.
“Blue-chip averages hit intraday and closing highs after minutes from last central bank meeting add to bets that the Fed can lower rates again this year.”
“The market had a desire to keep going up and there was nothing in the minutes to prevent it . . . The Dow and S&P 500 carving out fresh all-time highs will give the stock market more ammunition in the short term, he said, provided that the earnings don’t derail the momentum.”
“The minutes seemed to provide that evidence because of the combination of the concern about the economy and the diminished concerns about inflation. I think the market had a knee-jerk reaction to the idea that the Fed can cut rates more, if they need to”
Do we see a theme beginning to develop? The economy is ailing, but no matter for the markets. For as long as inflation is low and the Fed has the flexibility to ease, stocks can continue to stake out new highs. What could possibly go wrong?
The answer? Stocks can actually start to go down and begin to react to the reality around them. This is a story that is shown in pictures across two images below.
The first was the mild change in temperament that took place from October 2007 to September 2008. Yes, stocks had let off some steam in entering into a sustained decline. But through the last trading day before the weekend when Lehman Brothers declared bankruptcy, stocks had only fallen by -20%. We had only just begun to officially enter a new bear market when the market picture suddenly changed with broad policy strokes.
For once policy makers allowed Lehman Brothers to fail followed shortly after by the disintegration of American International Group (AIG), Washington Mutual, Wachovia and others, major investors were suddenly awoken to the idea that failure and the assumption of real losses was an actual reality in the post-1987 era Greenspan/Bernanke put markets. A stunning revelation even if it proved fleeting and was so quickly forgotten to the dismay of those in support of more free and balanced markets.
A healthy market is not one that is rising. Instead, it is one that reflects reality. And in October 2007, the market no longer reflected reality. Instead, it was being driven by the reflexive hope that easy Fed policy would save the day. For a time it did. And eventually it would do so in an incredibly more dramatic way come March 2009 and the years that followed.
Let us now continue on to the next collection in our gallery.
The next story begins with a market that was soaring nearly a generation ago now at the turn of the millennium and at the end of the last secular bull market. Stocks were once again an image of beauty from January 1999 to September 2000 in their tenth year of the longest sustained bull market in history.
Yes, stocks had technically peaked in March 2000, but they had gotten way ahead of themselves at that time, so a period of consolidation was naturally overdue. And in the months that followed, the S&P 500 Index was responding well both to its upward sloping trendline as well as its 200-day moving average in carving out a pattern of higher lows. By early September 2000, stocks were on course toward breaking out to fresh new all-time highs despite the fact that the economy was generally struggling outside of the teeming technology sector. Were stocks overvalued at the time? Yes, unbelievably so in fact with the trailing 12-month P/E ratio on the S&P 500 Index in the mid 20s. But investors took comfort in the fact that the world had changed, for according to esteemed market experts like Jeremy Siegel such “historical yardsticks for valuation have been rendered useless in the past.”
Or then again, maybe such yardsticks were actually still very relevant at the time. And perhaps such yardsticks including the Shiller 10-Year cyclically adjusted price-to-earnings ratio are still very relevant today despite protestations to the contrary. After all, the market can remain irrational far longer than imaginable. But when rationale finally returns, it can do so with a vengeance just as it did from September 2000 to March 2003.
As we finish the walk through our market exhibit, it is important to see that the final portrait remains unfinished.
We are now in the fourteenth year of the current secular bear market. Every secular bear market that has preceded the one we are in today has contained three major market corrections before drawing to a close. The first correction occurs as the excesses accumulated from the previous secular bull market finally boil over. The second correction occurs as a result of the flaws associated with the policy response to the first correction. And the third correction takes place as the natural market cleansing process finally plays out whether by force or by choice. It is only then that the secular bear market comes to a close and a new secular bull market can take flight. To date, we have experienced the first two corrections in the current secular bear market. And we are still awaiting the third. How the market fills the final blank canvas in our exhibit remains to be seen.
Disclaimer: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long stocks via the SPLV and XLU as well as selected individual stocks. I also hold a meaningful allocation to cash at the present time. (More…)