The bull market in global equities that started in the dark days of early 2009 passed a historic milestone in the second week of July. When the Standard & Poor’s 500 Index closed that Monday at 1682.5, this did not just represent a new record high and a full recovery from the swoon that Wall Street suffered after Ben Bernanke’s “tapering” comments in late May.
More importantly, Monday’s record close marked the first time this key Wall Street index exceeded by more than 10 per cent its peak at the climax of the last great bull market in March 2000.
Why is this important? Because a breakout this large from a trading range that has confined the stock market’s movements for many years is historically a rare event. In fact, there have only been three occasions in the past 100 years when prices have risen 10 percent above previous long-term peaks (which I define as peaks that have remained unbroken for at least five years).
Each of these major breaks — in July 1925, December 1954 and October 1980 — has confirmed a structural bull market and been followed by very large gains for long-term equity investors: 189 per cent from 1925 to 1929, 245 per cent from 1954 to 1973 and more than 1,000 per cent from 1981 to 2000.
Of course, past performance is not necessarily a guide to future results and three events are insufficient to draw statistically reliable conclusions. Nevertheless, the latest shattering of Wall Street records seems significant in several ways.
The S&P 500 is by far the most important stock market index and tends to set the direction for all other markets around the world — and history reveals that large breakthroughs, like the one that just occurred, are very different from marginal new highs, which have been much more common and have often given false signals.
There have been dozens of cases where long-standing records were broken by 2 or 3 per cent and several of these were followed by large losses instead of further gains. This happened most recently in 2007, when the S&P 500 squeaked through to a new high just 2.5 per cent above the 2000 record and then promptly collapsed during the Lehman crisis.
By contrast, large breakouts of 10 per cent or more have consistently produced large gains. This history, on its own, might not be worth remarking, since three events hardly qualify as a “pattern,” if it were not for some fundamental explanations suggested by this experience.
The three previous breakouts, in 1925, 1954 and 1980, have occurred at intervals of roughly 30 years and it is now 33 years since the last such event. So the mere passage of time suggests that a new structural bull market may be due around now.
More importantly, the alternation between bull and bear phases has been related to political and economic upheavals of historical proportions. The three long-term bear markets of the 20th century were related to World War One and the Russian Revolution, the Great Depression and World War Two, the great inflation and the energy crisis of the 1970s.
The transitions to bull markets happened when these crises were subsiding, even though few contemporary observers realised this at the time. In 1954, there were still widespread fears of a return to pre-war depression and even of a victory for communism in the Cold War.
In 1980, almost nobody expected inflation to be tamed by Ronald Reagan and Paul Volcker or for the oil shock to go into reverse. Yet investors on Wall Street got wind of these improvements and stock market prices started to set new highs well before the good news was confirmed.
Could something similar be happening today?
We know with hindsight that the origins of the 2008 financial crisis and the great recession that followed could be traced back to the start of the last decade, when incomes stopped growing for average American and European workers and their living standards could only be maintained through reckless credit expansion and the accumulation of unsustainable debts.
It seems reasonable, therefore, to view the whole period since 2000 as one of long-term structural deterioration and economic failure. Conventional wisdom maintains that this dismal period is still far from over and the structural obstacles to economic growth remain as daunting as ever — deteriorating demographics and weakening productivity, government deficits and unsustainable households debts, global imbalances and so on.
Yet there are signs that these structural impediments are gradually dwindling, especially in the US. Demographic prospects are improving because of immigration reform. Productivity breakthroughs are coming as manufacturing and computer technologies converge.
Household balance-sheets have strengthened and the US government’s deficit problems have been resolved, although a long-term challenge remains in controlling healthcare costs. Global imbalances have been largely eliminated, with the US current account deficit down from 6 per cent of GDP to 2.9 per cent, according to IMF projections, while the Chinese surplus has shrunk from 10 per cent to 2.6 per cent and Japan’s surplus has almost vanished.
None of this means that the US has fixed all its problems or that smooth sailing for the world economy lies ahead. Even if the US recovery continues and strengthens, as it probably will, new crises may be brewing in China and Europe.
But the world is always a dangerous and unpredictable place, which is why it is often said that “bull markets must climb a wall of worry.” This old investment adage is again being proven true.