Prepare for a 30-year bull market

Heading into 2017, Wall Street was excited by the prospect of a U.S. president who sympathized completely with business.  His promised tax and healthcare reforms were widely cheered by investors in the wake of his election.  Yet the Congress has so far failed to deliver on those promises and investors are no longer giving the Trump administration a free pass based on the assumption that tax breaks are on the way.

This loss of enthusiasm is reflected in the long periods of dullness the market has experienced since March.  While the bull market leg which began with the November election remains intact, the market has proceeded in a halting fashion and has gradually lost some of its erstwhile momentum.  The following graph illustrates this principle. 

Along these lines, a number of Wall Street economists have expressed the belief that if Trump’s promised reforms fail to materialize, the stock market’s current valuation precludes a continuation of the bull market.  There are a number of reasons why this statement is likely false, however, not the least of which is that the market doesn’t need a political excuse to rally.  Indeed, if that were the case then China’s equity market, in view of the country’s Communist government, would forever be stuck in neutral.  The pace of innovation and productivity in countries with a market-driven economy is consistently high enough to always provide some justification for higher valuations and stock prices, regardless of the political climate.

Writing nearly 200 years ago, Alexis de Tocqueville observed that in America no matter how much the tax burden increased, American ingenuity and resourcefulness always found a way to counteract its malignant effect.  He stated:

“It is certain that despotism ruins individuals by preventing them from producing wealth, much more than by depriving them of the wealth they have produced; it dries up the source of riches, whilst it usually respects acquired property.  Freedom, on the contrary, engenders far more benefits than it destroys; and the nations which are favored by free institutions invariably find that their resources increase even more rapidly than their taxes.”  [Democracy in America]

Tocqueville understood that America is unique among the nations in that its people and commercial spirit are strong enough to countervail even the most strenuous attempts by politicians at slowing commercial progress.   This principle is as true today as it was then, perhaps even more so.

While many analysts are concerned by currently high market valuation indicators, the reality is that valuations can climb considerably higher before the market is in imminent danger of a bear market.  The S&P 500 P/E ratio may be high at 26.13 by historical standards, it’s still a ways from those high levels in the late 1990’s/early 2000’s which preceded the death of the powerful ‘90’s bull market.  Moreover, price/earnings alone isn’t a reliable measure of how undervalued or overvalued a market is.  One must also take into account the investor sentiment backdrop, levels of participation among retail investors, and other technical and monetary policy factors when forming a final determination as to whether or not the market is truly “overvalued.” 

To illustrate how important it is to consider investor sentiment along with valuation, I reprint here the words of William Jiler, who wrote investment books in the 1960s.  Using International Business Machines (IBM) as an example, he wrote:

“How could [an investor] anticipate that IBM would sell as low as 12 times its annual profit in the late Nineteen Forties and at 60 times earnings in the late Fifties?  Obviously, ‘investor confidence’ went up sharply in the Fifties.  And obviously, the psychology of the market – that is, the sum of the attitudes of all potential buyers and sellers – is a crucial factor for determining prices.”  [How Charts Can Help You in the Stock Market]

The main consideration for stocks going forward is the level of participation among individual investors.  With investor sentiment still neutral and few small investors actively trading, the bull market still has plenty of room to run.  The informed investors who are keeping the bull market alive need someone to sell to when it finally comes time for them to unload their holdings.  That someone is the uninformed public which by and large has been afraid of owning stocks since the 2008 credit crash.  Until they rediscover the “joys of investing” the 8-year-old bull market will continue to age, all the while maintaining its vigor. 

History teaches that following a major financial crisis, a bull market lasting from around 20 to 30 years normally follows.  Such was the case following the Great Crash and Depression of the 1930s, the economic and political turmoil of the early 1970s, and in other eras in U.S. market history.  The last crisis in 2008-09 witnessed the birth of a new secular bull market which is already eight years old.  A generation is around 20-30 years, which partly explains why bull market typically last so long until the next great crash; it takes that long for the generation that experienced the last crisis to be replaced by an entirely new one which doesn’t remember it.  It’s only when the new generation has come of age that the mistakes which led to the previous crisis are repeated and the cycle begins anew.

Given that the current generation is still, nearly 10 years later, still averse to stocks to a large extent, the secular bull market has probably another 10-20 years to run before encountering the problems which always prove fatal to it.  I’m referring of course to the dangers of over-participation and excess enthusiasm.  Those dangers are nowhere in sight today.  We can therefore assume that the long-term bull market still has many more years to run before eventually reaching its terminus.   

Is the market all-knowing?

“The tape tells all” is a Wall Street bromide we’re all familiar with.  It neatly summarizes the belief that the major averages discount everything pertaining to the business outlook.  It’s also a basic tenet of Dow Theory.

Writing a century ago, Richard Wyckoff was one of the very first market pundits to put this belief in writing.  “The tape tells the news minutes, hours and days before the news tickers or newspapers and before it can become current gossip,” he wrote.  “Everything from a foreign war to the passing of a dividend; from a Supreme Court decision to the ravages of the boll-weevil is reflected primarily upon the tape.”

This sentiment was also eloquently summarized by author Robert Rhea over 80 years ago.  Writing in his classic book, The Dow Theory, Rhea observed:

“The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movement.  The averages quickly appraise such calamities as fire and earthquakes.”

The late Joe Granville took this a step further by suggesting that the stock market represents the sum total of a nation’s intelligence across many different fields.  He maintained that the market knows virtually everything worth knowing about the short-to-intermediate-term outlook.

Writing in September 2004, just after a devastating series of Florida hurricanes, Granville observed: “When the stock market turns down it is warning of trouble ahead.  It doesn’t matter what the trouble turns out to be…For a look at the future it was only necessary to follow the market instead of hurricane reports.”  In view of the vulnerable state of the market prior to the major hurricanes of 2005 and 2012 (Katrina and Sand), perhaps Granville was on to something.

Not all investors believe that Mr. Market reflects the sum of all wisdom as it pertains to the future outlook, however.  Proponents of Random Walk Theory in particular dismiss this notion with scorn.  But are they right to reject this proposition?

Experience has shown that Granville’s proposition is essentially correct, if overly simplistic.  To assume that the market always declines at the first scent of trouble would be the height of folly.  The collective wisdom of informed investors does tend to trace out its foresight in the charts, but it isn’t always blatantly obvious at first and sometimes is evident only in retrospect.  The market action of the year 2007 is instructive.  Consider that beginning in February that year the market commenced a series of volatility plunges as insiders first began to manifest their advance knowledge of the coming credit storm.

In between, and immediately after, the market plunges in February and August ’07, however, the S&P made new highs.  This was either a consequence of the recoil rallies going too far, or was the result of manipulation to disguise insider selling.  The lesson here is that while Mr. Market will usually provide advance warning signals for trouble on the horizon you must often pay close attention to discern those signals, for it isn’t always obvious. 

If the tape does indeed tell all, what is it telling us now?  The major indices and the NYSE breadth indicators have been in good shape for most of the year.  By the same token, cumulative trading volume has been subdued because of diminished participation among individual traders as passive ETF investing has gained popularity.  The major averages have been buoyant, but not lively, in recent months.  This has been reflected in the economic news for most of the year, and there have been no crisis events to speak of.  The market, in short, has been dull and listless in reflection of the lack of bad news news.  You could even say that the market has predicted the lethargic U.S. political/economic scene of recent months by its own lack of excitement. 

If the tape indeed tells all (and I believe it does), then it’s telling us that there are currently no major worries among informed investors and insiders about anything that might torpedo the U.S. ship of state and disturb the country’s equanimity.  Developments of this magnitude take time to develop and the traces of these dangers always eventually manifest in the stock market long before making an announcement anywhere else. 

This is not to say that the market will necessarily continue to experience smooth sailing for the balance of the year, as short-term volatility tends to be erratic and isn’t always predictable.  But the tape doesn’t suggest anything calamitous on the horizon, contrary to the warnings of the perpetual alarmists.  The secular bull market which began in 2009 is still very much intact with lots of room to run before entering those tumultuous shoals which always mark the end of the line.  By the time that point has arrived, however, the tape will have long since whispered the danger to those who bother to listen.