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.
To Summarize:
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.
.