The Bull Is Loose Again

While reading Michael Williams site Master of None, I came across this article from the Atlanta Constitution Journal celebrating the Bush Bull Market's first birthday.

It all sounds great and wonderful, right? Just one problem. Many of the historical comparisons are flat out false.

And if you've been out of the market over the last year -- tough. Consider what you missed:

As of Friday's close, the Dow Jones industrial average has risen 31.4 percent since Oct. 9, 2002.

The Standard & Poor's 500 index is up 32.6 percent.

And the technology-loaded Nasdaq composite index is up a stunning 68.8 percent.

Those gains rival historical norms (emphasis mine), including the robust annual growth rates of the 1990s market boom.

This is absolute, pure unadulterated bullshit. Those are not historical norms, they are a return to the unsustainable returns of the 1990s.

What are the normal numbers? Try this one for size:

Since the end of 1930 (we think it is appropriate to leave out 1929 and 1930), overall stock appreciation has averaged 8.8% a year. Total returns (appreciation plus dividends) have compounded at a rate of 11.5% (emphasis mine again) from 1931 to 1999.

Source: Financial Advisor Magazine

11.5%. That number jives pretty well with what is generally considered to be an aggressive equity based portfolio. In house research I've seen at now three different firms (two of them household names), plus research I personally did for one of my finance classes in college, indicate that the historical return for small cap stocks runs about 15%, for large cap stocks it's about 12%, so 11.5% isn't that far off from the numbers I'm accustomed to seeing. 30%+, that's not normal. That's a historical aberration.

For those who follow historical patterns, it's worth noting that the market started low and ended high in every decade (emphasis mine)since the 1930s.

Guess why they are using the decade time frame? Because that does not hold true over a five year span. But regardless, how relevant is it?

Again from Financial Advisor Magazine:

The very worst decade for total stock returns since 1930 was 1965-1974. The average annual total return for that awful period was 2.4%.

2.4%. Inflation generally runs higher than that. So while yes, the absolute dollar value of your investments would have risen over that decade time frame, the relative value would have declined. For perspective, according to the Department of Labor, Bureau of Labor Statistics, the cost of a $100 item in 1965 would have risen to $167.97 by the end of 1974, a 67.97% increase. By contrast, your $100 in an investment account would have gone from $100 in 1965 to $126.77 in 1974. In other words, your account went up, but you lost purchasing power. Ah the joys of inflation.

And here, I believe, is the truest reason for the bull market:

Still, after more than three brutal years, investors are more than a little gun-shy going into the final quarter of 2003.

This uncertainty is reflected in the decline in trading volume this year, even in the rally since March. Third-quarter New York Stock Exchange trading volume was about 12 percent less than the year-ago level, and was generally flat for the Nasdaq market.

This is also the most worrisome aspect of this bull market. A key that market technicians look for as an indicator of weakness is a rise on declining volume. Often times, it is the signal heralding a reversal in the general price trend. Without volume, this becomes a speculative bull market, not one based on investing, which points to it being short in duration and wild in the ride.

I'm glad to see the market performing somewhat better than it has over the last three years. Bush certainly didn't do anything (or fail to do something) to create the economic situation we're in now, this is the Clinton economic legacy. Bush's tax cuts probably helped some, but they were certainly not enough to have created a true long term bull market - that would require a fundamental and immediate change in the tax structure, not a phased in grouping of watered down half-measures (not all Bush's fault and still better than no tax cuts). This is probably more a case of the market reverting towards the mean. Let me explain.

Most market watchers use moving averages to smooth out the ups and downs of the market to get a general feel for the trend in a particular stock or index. Well the moving average also works like a magnet for the security being measured. If the security diverges too far from the moving average, it will attempt to revert to the mean.

In the late 90s, we diverged too far to the upside, and the market reverted back towards the mean in the form of a vicious bear market. Now as the market is wont to do, it overreacted. So now we're seeing a positive reversion to the mean. Same concept, different side of the curve.

Here is the biggest problem I see with this bull market: 36.79.

That's the current price to earnings ratio of the S&P 500. Again, for perspective, that number generally runs from somewhere around 16-20. Which in turn would point to the market being overvalued still by a factor of 1.75 to 2.25. Now I don't see the market dropping much more from here due to psychological factors, but I can see it remaining stagnant for a few more years as the fundamentals catch up to the price levels.

Like I said, it's good to see a Bush Bull Market and I hope that it gives him a boost politically, but this is a case where you have to keep your politics from blinding you from your investment goals. This market has a number of areas for concern. Invest as wisely as you politick.