Market Update: May 2021
The current bull market has been very unique. In previous cycles, such conditions would have led people to party like it is 1999; conversely, investors today are perennially worried. When stocks go up, people are worried they will crash and when stocks go down, people are worried this is the start of the “big one.” Because of this, potential investors continue to “sit out the party,” so to speak, while scoffing at speculative elements such as the daily barrage of news on each new Special Purpose Acquisition Company (SPAC) and cryptocurrency (dogecoin, anyone?). As a result, we often hear a similar question, something to the effect of “if this isn’t close to a top, then what is?” After all, “how long can the Federal Reserve keep the gas pedal on the floor?” and “why shouldn’t I be concerned that the craziness in the stocks of GameStop and Tesla is a harbinger of a market collapse?” And if there really is no substantive reason to be concerned right now, then “how long can the duration and magnitude of this bull market continue?”
The reality is that markets are far more complex than such questions would imply, which makes it impossible to answer any of these questions with the level of precision desired by investors.
Markets are an interaction of any number of factors, some of which are more relevant and important than others. But in the end, the prices of both individual stocks and the market as a whole result from a mosaic of data, similar to the way human decisions are based on myriad known and unknown factors. Benjamin Graham, whose perspective very much served as an investing template for Warren Buffett and who was dubbed “the father of Value investing,” metaphorized such a phenomenon via the anthropomorphic “Mr. Market.” Mr. Market experiences irrational mood changes daily, but he arrives at generally rational conclusions in the long run. Though we cannot predict what the market will do in the future, we can look to past cycles to see what possibilities may be in store.
Understanding Secular and Cyclical Markets
Figure 1 shows the S&P 500 progression of the S&P 500 index over the last 100 years. The chart is on a logarithmic scale to normalize percentage returns over different time periods throughout history. In the chart, secular markets and cyclical markets are isolated, as by one possible definition (more on this below). We define the markets as follows:
- A secular bull market is a persistent period with: 1) above-average returns, 2) relatively shallow and ephemeral drawdowns, and 3) relatively expedient recoveries from pullbacks.
- A secular bear market, in contrast with a secular bull market, is a period of: 1) consistently below-average returns, and 2) relatively sharp and lengthy drawdowns, and 3) relatively slow recoveries from pullbacks.
- A market is categorized as bull or bear over years-long stretches. Within these months, market prices may rise or fall, consistent with or counter to the overall trend (Figure 1). A cyclical bull market is a period within either a secular bull market or bear market where prices are rising. A cyclical bear market is a period within either a secular bull market or bear market where prices are falling.
The difference between secular markets and cyclical markets is an important distinction. Secular markets will not move uniformly in one direction; they are a series of cyclical markets. During the secular bull market from 1942–1966, there were three recessions, the Korean War, the Cuban Missile Crisis, and the JFK assassination. Similarly, the secular bull market of 1982–2000 saw its own litany of worries (as we detailed in our Wall of Worry reference in our 2020 Capital Markets Forecast), including, but not limited to, the 1987 Black Monday crash, the Savings and Loan crisis, the First Gulf War, the Asian Financial Crisis, the Russian Debt Crisis and the implosion of Long-Term Capital Management.
The point here is that markets do not get to their multi-decade peaks and troughs in one direction. We fully expect downturns and negative geopolitical events to occur during the remainder of the current secular bull market. And we further expect that these pullbacks will right themselves relatively quickly and will present buying opportunities.
Are we in a Secular Bull Market?
Having said all that, why do we think the market is still in a secular bull, and what are the possibilities? The answer to the first question is a tenet of our investment process – global stocks are not expensive relative to bonds. As we have previously indicated, historically, one factor present for the commencement of a bear market in equities is extremely expensive valuations relative to the valuation of bonds. Even with the recent market strength since the coronavirus crash on March 23, 2020, stocks are essentially neutrally-priced compared with bonds; they are neither overly expensive nor overly inexpensive. There has not been a bear market that has started under such conditions. Corrections and consolidations? Absolutely. But not bear markets.
So, what would the historical template say about the possible length and magnitude of this bull market? There are, of course, a litany of possibilities, and let us be clear that this is not about making a prediction but rather identifying some possibilities were the ongoing bull market to follow history. Let’s start by pointing out that there are two primary ways to market the end of secular bear markets and the onset of secular bull markets.
- A bear market ends at a trough, at which point the bull market commences (Figure 1).
- A new secular bull market does not start until the market breaches the peak of the prior bull market (Figure 2).
The end of a secular bear market may be suspected, but it is only confirmed in hindsight. Because the entrenched mentality is bearish, a rally will be perceived as a bounce in a bear market until the new bull market is confirmed via the new high.
For both methods, we can anticipate what each might look like by looking at magnitude and duration from the onset. Figures 3a and 3b detail the markets for each methodology.
A few notes about the data set:
- For the bull market leading into the Great Depression, we do not have data prior to 1921, so it is hard to use either methodology to compute the total length of that market. So, for this analysis, we will not include that bull market.
- Note that regardless of which methodology we use, historical template suggests there are many more years to run in the ongoing market (at least 13 years using methodology 1 and at least 6 years using methodology 2).
- Also of note is that the magnitude of the gains-to-date pale in comparison to those accrued in prior secular bull markets, again regardless of whichever methodology is used.
Historical Templates Suggest Bull Market May Continue
Using the returns accrued in prior bull markets, we see targets on the S&P as low as ~5300 (238.7% return applied to 1573.09, in line with the return during the 54-68 bull market in Methodology 1) and as high as ~17300 (1000.2% return applied to 1573.09, in line with the return during the 82-00 bull market in Methodology 2). Again, we stress we are not predicting either of these values or anything in between; rather we are merely pointing out that historical precedent would suggest that the ongoing bull market has the potential to continue in magnitude and duration. And as we said earlier, this idea correlates with our Tier 1 model, which assumes that equities are not currently expensive relative to bonds. Of course, this is always subject to change as market conditions develop. If rates move substantively higher (i.e., the price of bonds decline), then our model could indicate that equities have become expensive relative to the now-lowered bond prices. But the big takeaway is that relatively neutral valuations in tandem with historical precedent suggest that the bull market is not poised to end anytime soon or anywhere near current values.
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