Has a new long-term bull market begun?
Anatole KaletskyTwo months ago, when Wall Street first approached a record high, I warned about the dangers of “stock market vertigo” - a condition that combines the fear of buying shares at unsustainably high prices with the equal dread of not buying shares at prices that will never again be on offer if the market soars to permanently higher levels.
At that time the world’s most closely followed index, the Standard and Poor’s 500, was still bouncing along the top of a trading range that had held since the bursting of the Internet bubble in March 2000. There was no way to know whether the market’s next big move would be a plunge back toward the middle of this 13-year range or a rise to new and significantly higher records.
On one hand, improvements in the U.S. economic outlook and political situation at the end of last year suggested that a breakout was more likely than the last time the index came close to its 2000 peak - in late 2007, when the subprime mortgage crisis was just starting and George W. Bush was still president.
On the other hand, the European crisis looked as bad as ever, China seemed to be slowing, corporate profits were stalling and investors were well aware of the huge losses suffered by people who got sucked into the market when it hit similar levels in 2000 and 2007.
There was no sure way to resolve this dilemma two months ago, and there still isn’t, since prices in financial markets are always balanced, by definition, between bullish and bearish expectations that are roughly equal in plausibility.
But the market’s behavior sometimes suggests an answer - and this week appears to present such a case. In the week since last Friday, when the United Statesreported much stronger than expected employment growth, the S&P 500 has moved more than 4.0 percent above the 13-year trading range defined by the 2000 and 2007 highs. This breakout has been confirmed by the Dow Jones industrial average and by broader Wall Street indexes, such as the Wilshire 5000 and the S&P equal-weighted index. And while share prices in most other countries are still far below their 2000 and 2007 levels, the Tokyo stock market has taken off like a rocket and Germany’s DAX has matched Wall Street’s ascent.
This bullish behavior does not mean that prices will keep rising - by definition, the next daily move in any actively traded market is as likely to be down as up. But the records that have been set do mean that the plausible upside to stock prices is no longer limited to just a few percent, as it was when Wall Street seemed to be trapped in a range that had held for 13 years. Now that this range has been broken, historical patterns suggest further big gains in the years ahead, while a relapse into the old range seems unlikely. I described this in detail two months ago, so here is just a brief reprise.
In the past 100 years there have been eight occasions when stock prices on Wall Street, as gauged by the S&P 500 and its predecessor benchmarks, have broken long-standing records by 3.0 percent or more. All these records have been followed by further big price gains - doubling or tripling in the subsequent years, except for one occasion, when the S&P rose only 15 percent. None of these breakouts have been followed by a significant price decline for at least six months.
Of course, past experience is not necessarily a guide to future performance. Indeed, academic economists generally dismiss the “chartists” who study market history as irrational latter-day astrologers, exploiting the superstitions of naïve investors. But apart from the fact that chart-based technical trading accounts for the bulk of activity by the very investors assumed to be perfectly rational by the academic economists, there are several fundamental reasons to believe that this week’s stock market activity could mark the beginning of a long-term bull market and the end of the range-bound trading that has lasted for 13 years.
The first reason is the passage of time itself. When shares become overvalued, as they did in the boom of the late 1990s, they generally experience a price correction and a time correction. Stocks such as Microsoft, Intel and Amazon, which seemed ridiculously expensive at the market peak in March 2000, have become quite cheap as 13 years of growth in revenue and profit have finally caught up with exuberant expectations.
Second, cyclical and political conditions in the U.S. and Japan are clearly improving, growth in China and most of Asia is stabilizing at high levels, and stagnation insouthern Europe may matter no more to the world economy than Japan’s stagnation in the 1990s.
Finally, there is the shifting balance of structural forces discussed here last week. Everyone is now fully aware of the long-term challenges that investors ignored at their peril before the 2008 crisis: aging demographics, unsustainable debts, escalating health costs and so on. But during the crisis years it was easy to forget about the long-term opportunities that had excited investors and business leaders in the pre-crisis decades: the billions of new consumers and producers added to the global market; the reorganization of the entire world economy around capitalism and free trade; the new products, services and efficiencies offered by electronic technology, bioscience and now unconventional energy.
Nobody can say for sure whether the balance of long-term trends is genuinely shifting toward these growth-promoting forces (as I prematurely suggested three years ago in my book Capitalism 4.0). What is certain is that financial markets usually detect changes in economic conditions long before most economists, politicians and investors. By the time the reasons become obvious for a bull run on Wall Street, it is usually too late to join in.
Anatole Kaletsky is a Reuters columnist