volume xix - issue 3
How Long the Bull?
All index prices are day-end with decimals omitted unless otherwise noted.
The S&P 500 Index passed a milestone at 3000 in July, truly an achievement of the longest bull market in history. And it bears plenty of notice. But this article is about perspective. Over a twenty-year span, 3000 is not such a big number.
I would like to ask the reader to humor me and consider it significant when the Index has crossed an upward bound, non-arbitrary threshold of 1500. This has happened three times. Twice the market retreated to roughly half that number. The Index first crossed 1500, then reached 1527, a rarefied milestone, on March 24, 2000. Y2K – The Dot Com Boom. By October 2002, the Boom had gone Bust. Soon following Nine-Eleven, the index cratered to 776. Almost half the peak value.
The most brutal stock market routs stem from broadly mispriced assets in large markets experiencing hoards of new cash invested. In the Dot Com era, frothy stock IPOs for new tech companies poorly reflected the truth that most had never earned a dime before going public and had no tangible prospects of ever breaking even. Promoting the bonds and collateralized debt of independent telecom companies as safe havens was another sham. WorldCom was not Ma Bell (AT&T), a regulated utility with a guaranteed income stream.
Finding the Bottom
This is what happens with every big stock market crash. Some structural element of the financial system becomes impossible to price and the assets must be marked down once realizing that those holding the assets – pros and moms and pops alike – won’t be getting their money back. Sounds like musical chairs doesn’t it?
The bust following Y2K was the first of two striking retreats from 1500 for the S&P 500. The years 2000 – 2010 were labeled “The Lost Decade” for shares of Information Technology companies, particularly telecommunications. It took eight years for the Market to return to the 1500’s, breaking the barrier again in 2007 and peaking October 9th that year at 1565.
This time, mortgage backed securities were the unpriceable assets. I recall at the time listening to a morning report on CNBC, that the size of the secondary market for mortgage backed securities had grown to three times the value of the US Treasury market. I gasped a little, and within the following weeks went to cash in portfolios except for the large, stodgy mega-cap and old money stocks that historically survive economic crises. Fortunately I side-stepped the slaughter coming up. The Big Short.
And so, the Mortgage Crisis ensued in 2008. Lehman Brothers went bankrupt, the largest in history. AIG and Bear Stearns nearly did; the latter bought by JP Morgan for $2 per share. Bank of America acquired Countrywide Mortgage and Merrill Lynch. The government quickly passed the Troubled Assets Relief Program (TARP), allowing the distribution of over $700B in liquidity to the largest US banks.
At the bottom, March 6, 2009, the Index had collapsed intraday to 666.79 but rallied. The lowest daily close came through a few days later, March 9, at 676 – lower than the bottom following the Dot Com Bust and the Nine-Eleven attacks. All the major brokerage firms were now owned by large banks under the jurisdiction of the Federal Reserve.
These banks, were given greater access to short term credit through the Fed Funds Discount Window, under the guise “Too Big To Fail”. Morgan Stanley and Goldman Sachs were the only two large investment banks still standing. They formed bank holding companies and grudgingly acquiesced to direction from Congress and control by the Fed.
It’s Just a Double
The Great Recession followed. But the S&P 500 Index climbed again and that value on March 6, 2009 of 666 stands as the most recent low point marking the start of a bull market that is now over ten years old. The media is celebrating the performance of the market as measured from the bottom, clearly through 1500 in 2013, and continuing uninhibited to 3000 last month. The statistics are accurate. The path from 666 to 3000 is four-and-a-half times your money from-trough-to-recent-peak. Astounding. Even accounting for a possible correction underway.
But here’s the thing: If you bought the S&P 500 Index, meaning “The Market” near the top of the Dot Com Boom, peaking near 1500, it would have taken nine years to reach that level again before the mortgage crisis. Then again dropping to half its value. Ten years later, here we are toying with 3000. This is only – not to discredit – a 100% gain, or double your money, over a few months more than nineteen years.
If you invested $5 in The Market in 1999, you would have about $10 now. I’ll do the math here. That’s about 5% annually without compounding, without inflation adjustment. The compounded annual rate of return for the S&P 500 over those twenty years is closer to 3.5%. When accounting for inflation, the ROR is actually worse. The long-term statistical mean of the S&P 500 is 8% annually with an 18% swing in one standard deviation. The actual twenty-year average return from 1999 to 2019 is nowhere near the mean.
Healthy Sector Rotation and Market Cycles
I recently completed a fifteen-year look back into the prices of the stocks of deliberately non-tech companies and have decided they are fairly priced. This opinion based on dividend yields, relative price to earnings ratios and a few other fundamentals. It’s boring but stocks of energy, natural resource and utility companies, and consumer brands that pay dividends are safe bets now.
This economy is quietly going through about as normal a sector rotation as I can remember since joining the investment finance business in 1985. Prolonged periods of low interest rates impact the banks, but that industry has been steadily on the mend. Growth in fee-based services is replacing money earned on the spread; the difference between the bank’s borrowing cost and the rates they charge as interest on loans to consumers and businesses.
The energy sector rolled over in 2015 when the fracking boom peaked. It became apparent that we have enough of our own energy resources to last without foreign imports. Most analysts believe that oil and gas prices have already reached the bottom of their cycle. I do, too.
Industrials and the manufacturing sectors are further along in the economic cycle, so I wouldn’t be surprised with a pullback here, but not like the breakdown in 1999 – 2002. Semiconductors peaked in 2017 and some have dropped by half their value. They had also in part fueled the ride up to 3000. But sector woes haven’t taken the broader industrial economy along with it.
Late Stagers Still Need to Peak and There is Cautious Upside
The S&P 500 and the Dow Jones Industrial Average are now heavily Information Technology weighted and that won’t change. This isn’t your grandfather’s portfolio. Of the 30 Dow Industrials, Apple, Cisco, IBM, Intel, and Microsoft are included. In the S&P 500, these stocks and the FANG Gang – Facebook, Amazon, Netflix and Google – are prominently represented due to their size. Their extraordinary new highs make the news. These stocks and companies like them are the most exposed to a correction and most heavily weigh on the price of the S&P 500 Index.
Consumer spending, jobs, the service economy, software, and military spending are usually the last to peak and we haven’t seen it. We have yet to show any real evidence that the economy is slowing down in a dramatic way. So, take a breath here. Consider raising some cash and increasing positions in safe-haven assets but don’t go overboard.
Sector rotation describes a healthy economy. Daily ups and downs that follow the news – China Trade, Brexit, the behavior of Iran and North Korea, an upcoming election and ongoing Congressional angst – are offset by cuts in corporate tax rates, share buybacks, more than a decade of low interest rates and a sensible Fed. Taking the long view, the Market knows what it’s doing and a double-the-money in twenty years means statistically there is more room for the bull to run.
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