Influences That Cause Stock Market Super-Cycles
It might be helpful to consider the underlying changes that have driven super-bear markets and super-bull markets over the decades. Unfortunately, it's hard to associate similar conditions with the three "super-cycles".
1871 to 1929
The story picks up in 1871, just after the Civil War. This was a period that saw the colonization of the West, the Industrial Revolution, and the U. S.' territorial adventures in Panama and the Philippines. During this period, the stock market remained between what we would now perceive to be the top and the middle of its range. Then came World War I, followed by the Roaring Twenties.
The Crash of '29 and the Great Depression
When the stock market reached its peak in 1929, it was at the top of its range, and was ripe for decline, but it wasn't higher than it had been at previous peaks. What may have fueled the Crash were the extremely dangerous margin requirements (requiring only 10% down), and reckless investing by a large fraction of the population. This was allegedly followed by a fatal mistake by the inexperienced Federal Reserve: raising instead of lowering interest rates. People panicked, and stopped spending money. Factories began to lay off employees, leading to further panic, and reticence to spend money, leading to further layoffs, leading to further declines in consumer confidence... and so forth. Herbert Hoover's government tried to pretend the problem wasn't there. By the time the next presidential election arrived in 1932, unemployment had risen to 40%, there were runs on the banks, and there were massive foreclosures of mortgages as banks tried to raise cash for their depositors. The country was on the verge of revolution when Franklin D. Roosevelt was elected president in November, 1932, and began to turn the tide. He made it illegal to own (and hoard) gold, and he established federal programs such as the WPA (Works Progress Administration), the NRA (National Reconstruction Act) and the CCC (Civilian Conservation Corps) that hired the unemployed and got them working on programs of value to the public. Pay was low ($50 a month for the WPA), but it kept families from starving, and blunted the worst of the discontent.
The Great Depression continued until World War II began in December, 1941. At that time, price and wage controls were established to keep inflation in check.
The Postwar Era (1945 - 1966)
Throughout this period, the general public was deathly afraid of the stock market because of what had happened in 1929, and its aftermath. By 1950, a few hardy souls began to invest again, but not much attention was paid to the stock market until the 60's. By the 1960's, it had become apparent that the country wasn't in danger of sinking back into the Depression, and a new generation of potential investors had appeared upon the scene, with the victims of the 1929 Crash heading into retirement. The 40's, 50's, and 60's had been a period of low interest rates, and of economic stability and prosperity. Mutual funds had made their debut, and had become a popular vehicle for obtaining professional, large-investor advantages, with only a small fee for fund management--money that the management took out of the money they were earning for their investors.
The Super-Bear Market of 1966 - 1982
In the latter 60's, LBJ was trying to fund his "Great Society" and war on poverty, while simultaneously. financing the Viet Nam War. The government quietly began to "print money" and fuel inflation. The economy began to overheat, with a wage-price spiral developing, as unions insisted on cost-of-living raises designed to offset the inflationary erosion of their members' purchasing power. In 1968, the Federal Reserve began raising interest rates to bring inflation under control, and the stock began to decline in anticipation of an approaching recession brought on by the higher interest rates. In 1970, the stock market hit bottom, recovering again just in time for President Nixon's 1972 re-election, as the Federal Reserve stimulated the economy by lowering interest rates. In January, 1973, the stock market reached and even slightly exceeded its peaks in 1966-68, but after inflation, it was well below those levels. At this time, professional investors celebrated the wonderful money-making machines that they dubbed "the Nifty Fifty". The "Nifty Fifty" included such companies as IBM, Xerox and Polaroid, that grew dependably at 20% to 30% a year.
Once again, the Federal Reserve raised interest rates in anticipation of the next wave of the four-year cycle. In 1974, the country entered a deep recession, culminating in the chilling bear market of 1974. The "Nifty Fifty" were smashed flat. They had gotten very overpriced, and it was belatedly recognized that they had grown so big that they had saturated their markets and wouldn't be able to continue their 20%-to-30% growth rates. Suddenly. all of their protagonists abandoned them, and couldn't find enough "greater fools" who wanted to buy them. A lot of investors took a bath.
The secondary market was especially hard-hit in the 1974 debacle, and offered great buying opportunities.
During President Carter's administration from 1976 through 1980, no attempt was made to raise interest rates, and by 1980, inflation was rampant. The Chairman of the Federal Reserve began raising interest rates just before the presidential election, thereby insuring President Carter's defeat. The stock market continued to rise until June, 1981. By that time, the worst recession since the Great Depression was fast approaching, as Fed Chairman Paul Volcker struggled to rein in our runaway, double-digit inflation. In the fall of 1981, the interest on 30-year Treasury bonds hit 16%.
In August, 1982, the stock market hit a low of 776 on the Dow. Corrected for inflation that was less than one-third of what it had been at its peak in 1966. A week later, Chairman Volcker lowered interest rates, and the great bull market of the 80's and 90's got underway.
The Super-Bull Market of 1982 to 2000
In 1987, Alan Greenspan, who had just taken the reins at the Fed, began raising interest rates to cool the economy. In October, the Crash of '87 occurred, brought on by computerized trading, in which computers began to respond to each other's actions in an unstable way. As was the case in 1929, the stock market was at the top of its range, but it wasn't above its normal range. Alan Greenspan moved immediately to lower interest rates and to promise banks that the federal government would guarantee their ability to repay depositors. (Bank accounts are insured up to $100,000 per account by the Federal Deposit Insurance Corporation, but there was concern that the corporation didn't have enough cash to make good on their guarantees if very many banks defaulted at the same time.) Within a year, the stock market had recovered its pre-Crash values.
In 1990, there was a mild, brief recession that coincided with the Gulf War. The stock market dipped briefly, but took off again as soon as it was apparent that the Gulf war had been favorably resolved.
The rest of the story, dealing with the sudden surge from 1995 through 1999 I've already covered.
The super-cycle between the Crash of '29 and the peak of 1966 doesn't seem to me to have been interest-rate driven, but rather. a consequence of the trauma of the 1929 Crash and then the Great Depression. World War II terminated the Depression, followed by a few years of postwar transition as factories gradually satisfied pent-up demand for consumer products, and ex-GI's attended college. By 1950, a new generation was ready for jobs, houses, and families.
The super-cycle between 1966 and 2000 was interest-rate driven.
I lack the knowledge to assess what happened in the years leading up to the 1920's.
What Happens Next?
Dealing strictly with the next two years, it still isn't a sure thing that small investors will plunge back into equities. Since February, the yield on 10-year Treasury bonds has risen from 4.9% to 5.3%. Meanwhile, the earnings yield that I calculate for the S&P 500 is 4.6%. Of course, earnings are expected to rise rapidly as the economy recovers from its mild recession. Earnings on the S&P were $57 a share in 2000. This year, they're projected at $52 a share, increasing to $63 a share in 2004. 2005 projected earnings in 2004 might be $67 a share, conceivably fueling an S&P index of $67/$57 X 1400+ = 1646+. However, with interest rates on the 10-year Treasury bonds on the rise, I wouldn't expect that high a value for the S&P in 2004. If parity between the 10-year Treasury bond yield and the earnings yield on the S&P 500 is our only yardstick for determining fair market price for the S&P 500, then a rising yield curve would be expected to take its toll on future S&P valuations. One of the problems is that part of the recovery has already occurred. At 10200, the Dow currently stands 16% above its September 19th low point. If the S&P 500 reaches 1500, that would constitute a 50% gain from its low of 1000(?) last September 19th. If it gets to its March, 2000, peak value of 1400+, that would constitute a very respectable recovery of 34%. Of course, after adjusting for inflation, 1400 in 2004 would be equivalent to only about 1260 in 2000.
We might very well see a deflation of the stock market over the next decade or so, with part of the damage masked by inflation..
What is really important is that the secondary stocks recover... i. e., that the NASDAQ composite index move back toward its high of 4000. That would be my white hope. I don't expect the S&P 500 to grow much beyond its year 2000 apex of 1400, if it gets that high. But a recovery in the NASDAQ index would more than double most technology stocks (excluding telecommunications stocks, which I don't see recovering for several years, and then only those that haven't been forced into bankruptcy)..
I have yet to contact anyone about this, and its certainly time for that. I'd like to think I'm wrong, and that the stock market will keep on rising. That may well be the case, but I don't yet see that.