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Cyclical Bull, Secular Bear
A bull market is unofficially defined as a move of 20% or more from a low. By those unofficial standards then, we are in a bull market. In fact, it is the greatest bull market in 70 years!
The S&P 500 is up 63% from its March low, which leaves one to wonder if we are witnessing the start of the next great bull market -- not just any bull market, but a secular bull market that resembles the bygone bull market era of 1982-2000.
Our sense of wonderment today isn't as great as that of others. We believe we are witnessing a cyclical bull market within a secular bear market.
Been There, Done That
That's a mouthful -- a cyclical bull market within a secular bear market -- but the basic meaning is that these current good times aren't built to last for the stock market. Accordingly, a buy-and-hold-and forget investment strategy shouldn't be taken for granted.
What the cyclical bull market giveth, the secular bear market can taketh away.
Ask any long-term investor in Japan's Nikkei and they'll confirm that assertion.
After the Nikkei's implosion from 1990-1992, the Nikkei increased in value three straight years between 1993 and 1995, logged a 36.8% gain in 1999, and enjoyed four straight increases between 2003 and 2006, including a 40.2% increase in 2005. The Nikkei, in fact, doubled in price between the end of 2002 and 2006.
The intervening years between these winning periods, however, were all down years.
The most sobering point in this history is that the Nikkei ended 2008 at a 26-year low. Even with this year's 16% gain, the Nikkei is still at levels that were also seen in 1984 -- or about the time the last secular bull market in the U.S. was just getting going.
Room with A View
Turning our attention back to home, the U.S. economy has endured its longest downturn in the post-World War II era with four straight quarterly declines in GDP. Ironically, this inauspicious streak, which should come to an end with the third quarter report, has the market feeling good about what lies ahead.
The simple sense of things is that it can't get any worse.
We certainly hope that is the case, but absent in that current perspective is an appreciation for a longer-term outlook that appears less exciting when considering secular bull market possibilities today versus the period leading up to the great bull market of 1982-2000.
Fundamental drivers back then left ample room for improvement. Fundamental drivers today, meanwhile, leave ample room for deterioration.
The table below encapsulates this concerning message with a presentation of what key data points revealed at the end of 1981 and what those same data points are showing today.
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(a) For individuals with taxable income over $212,000 (source: National
Taxpayers Union)
(b) For individuals with income over $357,700
(c) This will jump to 20% after 2010
(d) Source: Fed's Survey of Consumer Finances (1983 earliest
publication)
(e) CBO's Baseline Budget Outlook
Writing on the Wall
The greatest thing going for the secular bull market of 1982-2000 was the long-term decline in interest rates. That steady decline was the result of a hawkish Fed intent on getting inflation under control.
Hiking rates in the midst of a recession wasn't popular, but it was the necessary cure for slaying inflation. As inflation pressures abated, the fed funds rate declined as did nominal and real market rates.
Source: Bloomberg: Briefing.com calculations
Today the path of least resistance for interest rates is higher and it won't be because the Fed is starting off trying to slay high inflation rates. Rather, it will be because the Fed is trying to prevent high inflation.
A number of Fed officials have already served notice that the Fed will likely need to be aggressive tightening monetary policy as it tries to preempt an unwelcome, and sustained, rise in inflation pressures that are sure to build with a recovering economy.
Although we think the first tightening is apt to wait until 2011, the writing is on the wall.
Short-term rates are going up and long-term rates will follow. This upward adjustment in the interest rate complex will make it more expensive than it is today to borrow money, which will cut into corporate earnings, consumers' disposable income, and economic growth.
Rising interest rates, though, may not necessarily wait on the Fed.
The ever-growing budget deficit is pregnant with interest rate risk. U.S. creditors are expected to demand higher returns to compensate for the growing concern about the U.S. government's fiscal situation.
That situation is even more burdensome than it appears, too, when taking into account the specter of Social Security, Medicare, and Medicaid expenses to meet the needs of an aging population.
No Kidding Around
The deficit is probably the greatest threat to the secular bull market possibility. In an attempt to control it, taxes are going up, most certainly for high income individuals/couples and most probably for everyone else in one form or another.
Tax reform efforts in the early 1980s were an appropriate spending stimulus and there was a lot of room to cut rates. The highest marginal tax rate back then was just north of 69%.
Today the highest marginal tax rate is 35%, which is rather scary knowing the federal deficit was 2.5% of nominal GDP at the end of 1981 and is estimated by the Office of Management and Budget to be 11.2% for fiscal 2009.
Don't kid yourself if you think your taxes aren't going up in the coming years.
Higher taxes will leave less in consumers' pockets, which is an introduction to saying our standard of living looks destined to go down in coming years.
Spending Boom to Spending Swoon
Consumer spending activity also seems destined to go down given that the 80 million or so baby boomers were between the ages of 17 and 35 at the start of the 1982 bull market and are now between the ages of 45 and 63 today. Their prime earning and spending years are dwindling, whereas before they all had those years still to come.
Baby boomers will of course still do their fair share of spending on goods and services, but they will undoubtedly need to be more conscientious about it as they try to rebuild savings lost in the simultaneous stock market and housing market crashes as they maintain an eye toward retirement.
There is no mistaking the consumer-oriented ways of the baby boomers either.
It is little coincidence that the personal savings rate dropped from 11.4% at the end of 1981 to 2.1% at the end of 2000 (it is 3.0% today), that personal spending increased from 61.9% of GDP to 68.9% (it is 70.7% today), that household debt as a percentage of personal income increased from 56.1% to 80.3% (it is 114% today), and that household debt as a percentage of GDP rose from 47.2% to 69.2% (it is 96.8% today).
Granted household net worth is five times as high today as it was at the end of 1981, yet mortgage debt as a percentage of disposable income has risen from 43.1% at the end of 1981 to 95% today, signaling that we have become a house-poor nation.
From 401(k) to 301(k) to 201(k)...?
Another limitation as far as the stock market itself is concerned is the household embrace of participating in defined contribution plans.
Over the past 30 years, there has been a massive boom in 401(k) and IRA plans. According to the Fed's Survey of Consumer Finances, 24.2% of all families had retirement accounts in 1983. That number has since increased to 52.6% based on the latest available survey, which dates to 2007.
There may be room for expansion still, but we won't see anywhere near the increased involvement that helped drive the last secular bull market.
If anything, there is a risk that the participation rate goes down as two massive bear markets in a span of 10 years has potentially disenfranchised an entire generation of prospective investors, as well as existing ones.
Regulation Coming
Then, of course, we're entering a period where Washington's efforts are geared toward increasing regulation, particularly for the financial sector, versus the movement toward deregulation in the early 1980s.
Regulatory reform is certainly needed in some instances, but the bottom-line is that the more restrictions that are placed on how business is conducted, the less opportunity there is to maximize profit potential.
What It All Means
All of this isn't to say the stock market is set for an imminent collapse. On the contrary, the near-term outlook appears to be favorable with easy comparison periods approaching, stimulus efforts continuing, and ultra-low cash returns driving the need to find higher-yielding assets.
Plenty of money can be made in cyclical bull markets, as we're seeing today. Unfortunately, the forces needed to turn this cyclical bull market into a secular bull market just aren't there today.
Tax rates, interest rates, inflation rates, the savings rate and regulatory efforts are all due to increase while borrowing activity, spending by baby boomers, and the American standard of living won't be what they used to be in the bygone era of 1982-2000.
Take advantage then of the cyclical bull moves when they happen. Just don't take for granted that they will last indefinitely.
We're not going back to the future.
Feeds!