Copyright 2012. Tom Madell, PhD, Publisher
-Bull Markets and Investor Pessimism: Why the Huge Disconnect?
by Tom Madell
-Lessons From the Ten Year Treasury Benchmark
By Steve Shefler (on separate page - to view, click here)
I am not big on trying to impress people with fancy terms, but the term "bull market" is one that should have obvious importance to investors. And guess what? There appears to be near universal agreement that we are now definitely in one.
Never mind that some might argue we are only temporarily in a short-term "cyclical" bull market within what they see as at best a directionless long-term market, or at worst, a secular bear market that might have started as far back as 2000 or as relatively recently as 2007. What does matter is that the current bull market should be viewed as your friend for as long as the upward trend remains in place. And it could be for quite a while and with considerable additional gains still ahead.
While the naysayers might scoff and point out that even the recognition of a current bull market may have little significance since what goes up can easily go down, we tend to disagree. The markets tend to get locked into longer-term trends which are more characteristic of how they move than with the absence of few long-term trends, characterized instead by a generally rambling and random, helter-skelter pattern of relatively short-term ups and downs.
How does one know that we are in a bull market? Sticking with a straightforward definition, a bull market in stocks means that the relevant indices have registered a 20% or more gain from a previous low. The most recent low in the S&P 500 Index was back on Oct. 4, 2011 when it reached approximately 1,075 during trading. Since then, it has climbed as high as about 1372 on Feb 27th (when we went to press) which is a gain of about 28%.
Likewise, other indices such as the Dow, the Nasdaq, the Russell 2000 (small caps), Stoxx Europe 600 Index, and the MSCI All-Country World Index have all risen 20% or more too. Therefore, there should be little doubt that we are in a bull market. And, by definition, the current bull market in an index will remain in effect until there is a 20% drop in that index.
This brings us to a related question: Did the current bull market really just begin in October or have we actually been in a bull market since March 2009?
I think this is largely a matter of semantics, but I'll register the opinion that we have been in a bull market since early March 2009 when the prior severe bear market that accompanied the 2007-2009 recession ended. At that time, the S&P 500 registered as low as about 667 on Mar. 6 which is less than 1/2 of its recent level. Since then it steadily climbed without a 20% loss until that Oct. 4, 2011 date.
If you look at the intra-day high on May 2, 2011 of about 1371 and the low during the day on Oct. 4 of 1,075, the drop was about 22%. However, if you look at the drop using the closing prices of 1364 on Apr. 29 and of 1099 on Oct. 3, the drop was just short of 20%. This, technically, would mean that a bear market just missed having occurred; if so, we're still in the bull market that began in 2009. Are these small differences on these few days really important enough to define the end of a long-term bull market? Not to me. Rather, just looking at a chart of the index, I would rather go by the bigger picture showing that the basic trend since Mar. '09 has been nothing but up except for some relatively short-term holding patterns.
But, in spite of the good news, should one give any credibility to the view that we are actually still locked in an even longer-term secular bear market, given the S&P 500 hasn't yet recaptured its record intra-day high of about 1,576 in Oct. '07 or even its pre-dot.com crash high of about 1,553 in Mar '00, as is sometimes argued by others?
Whatever technical merits this argument may have to its adherents, the fact is that there have been enough periods of long-term gains that any investor who followed the markets ups and downs would likely have been rewarded by emphasizing investing in the good periods while cutting back in the bad periods. So the fact that we are in one of those good periods, whether it is a "new" bull market, or just a continuation of an older one should be welcome news to investors who believe in the thesis of maximizing their stock investments during the good stretches and trimming down during the bad ones.
The fact that we are currently up more than 20% since early October, and therefore in a bull market, hasn't been noticed as much as one might expect by the media, and therefore, apparently by investors either.
Recently, though, the Feb. 11th cover story of Barron's was entitled "Enter the Bull." It predicted that the Dow Jones Industrial Average will hit 15,000 over the next two years; it's currently at 12,982. The article, which bases its conclusions on the historical patterns of market highs and lows, professes that the odds for reaching this level are better than 2 out of 3. And it further claims there is roughly "a 50-50 chance that the Dow could hit 17,000 or more." The data in the article is based on the research of Jeremy Siegel, noted professor and author of the widely read book "Stocks for the Long Run." As the title implies, Mr. Siegel has often been called a permabull in that he seems to see only the positive.
Data, however, show that Mr. Siegel, like most forecasters, has a flawed record of predicting the stock market. For example, in 2007 he made several terribly wrong predictions: 1) that a recession would be avoided in 2008, therefore concluding that stocks would have another "winning" year; 2) that financial stocks which suffered badly in 2007 would "outperform" in 2008. As we know, he was wrong in a big way on all counts. In fact, financials underperformed everything else, down about 57%. Therefore, if you tend to look at such predictions as his as more of a hit-miss proposition than gospel, why should you trust his predictions now?
Research shows that the average stock cyclical bull market lasts about two years. Thus, if we are in a "new" bull market that began in Oct., we could easily still have over a year and a half left before it withers away. But, if we are in a longer-term bull market that began in March '09, we could actually be locked into the type of secular bull market that lasts many, many years. In either case, then, it would appear that the odds seem to favor those who, at least for the time being, become fully invested to their maximum level of comfort.
Ken Fisher, who writes for Forbes, and who unlike Siegel, does have a good track record on his stock market calls (for example, he was very bearish from the beginning of 2001 through summer 2002, basically correct between 2004 and 2007, wrong for same period as Siegel above, but essentially correct for 2009 through the present) wrote on Feb. 8th: "We will soon begin the fourth year of this bull market. According to my research, fourth years have averaged 20% returns and sometimes have been much bigger. So it is best to think of the directionless daze the market suffered in 2011 as the pause that refreshes before the bull resumes." It appears he has already been correct about the bull resuming; perhaps his future optimism will turn out to have been correct as well.
Why aren't many investors more fully aware of the extent of this bull market, or even if they are, tending to remain skeptical and under-invested in stocks? Let's look at some of the evidence of this and some less than obvious reasons for it:
In general, investors have been getting out of their stock mutual funds for quite a while now: Even as the new or continuing bull market progressed, US investors have withdrawn $76 billion from long-term equity funds since late Sept. 2011 as of early February according to recent data. While the Russell 2000 Index of small-cap stocks has jumped as much as 38% since its Oct. lows, investors have continued to withdraw from these funds in 37 of last 40 weeks according to a recent Wall Street Journal article.
In fact, according to well-known fund manager Brian Rogers, whose T. Rowe Price Equity Income Fund has been recommended many times in my Model Portfolios, many investors are currently showing what he calls "irrational pessimism." This is a play on the words spoken by former Fed Chairman Alan Greenspan who referred to stock investors' surprising enthusiasm, back in 1996, as "irrational exuberance." Why have many investors been so hesitant to embrace stocks? Apparently because of lingering economic issues, and unresolved and festering possible but yet to actually materialize future crises that some continue to fear could topple the markets. But more important in his view, Rogers sees stocks as basically undervalued and, therefore, well-positioned for future gains.
Interestingly, Rogers initially coined his irrational pessimism term back in Oct. 2008. At the time, the S&P 500 had dropped about 35% from its Oct. '07 highs, but unbeknownst to him, still had about 20% more to drop.
So was Rogers wrong? Had one bought the Vanguard 500 Index on the date he spoke, the return since has been about 44% over the following nearly 3 1/2 years including dividends, or close to 13% annualized. So, even while someone who acted on Roger's assumption of undervaluation would have continued to suffer big losses for another 5 mos., the overall outcome has still been quite favorable.
Of course, as shown, even a market that is undervalued can continue to get considerably more so. But over the longer term, Rogers' seemingly ill-timed view would have led to far better returns than investors would have achieved by remaining on the sidelines, or even by investing in some of the highest performing bond funds. This example shows that even if you suffer a big drop right after making an investment, it is still possible for things to turn out well if your basic premise, one of undervaluation, was correct and you have adopted a long-term approach.
Obviously, as investors get closer to retirement, or even enter it, they tend to become more conservative. They can no longer afford to lose a big chunk of their assets that they must count on once their salaried income stops, nor will they likely have a sufficient number of years ahead to recoup big losses. And given recent stock market volatility and the two major bear markets between 2000 and 2009, it is understandable that these older investors may have pulled back. But, according to a recent Harris Poll survey released in February, it is actually people in their 20s who have become the most conservative of all age groups, even more so than investors age 65 and older!
In fact, the results show 41 percent of those between ages 18 and 33 report their personal savings are mostly "invested" in bank savings accounts and CDs. This compares with 31 percent for retirees. (I use quotes around "invested" to reflect my view that such savings should not be considered investments because they currently are guaranteed a negative rate of return when considering inflation and taxes; a true investment should reflect the potentiality to grow one's assets.) Further, few in their 20s own a significant amount of stocks/stock funds (7%), bonds/bond funds or money market funds (4%), or a diversified mix of funds (7%), all in the smallest proportions of any age group.
A different survey found that investors, born in the 1980s and later, are "investing more like their parents and grandparents, many of whom grew up in the shadow of the Great Depression,” according to William Finnegan, a executive at MFS Investment Management. And a 2011 survey for Fidelity found that, within this same age group who invest in retirement plans, they respond in a similar fashion as older investors, with nearly half of all respondents, regardless of age, calling themselves "conservative investors."
For younger investors, having seen more than a decade of flat investment returns for stocks ever since they became of investing age, many have no confidence that the stock market is a good place to invest, no matter what it did before they came of age. Needless to say, wise financial planning suggests that younger investors, with likely many decades until retirement, should typically be considerably less risk-averse than workers much closer to when they will need to actually begin accessing their retirement funds.
Here is a final contradiction to ponder: Day after day, we are exposed to media reports that the economy is still issue number one for so many struggling Americans. This has basically been true since the financial crisis really started to impact the economy in the latter half of 2008. Yet the stock market has been experiencing an extraordinary growth phase over nearly the last three years with the S&P 500 up well over 100% since the Mar. '09 low. How can one explain this huge disconnect?
Many investors fail to recognize that stocks are often impervious to the day-to-day world, no matter how obviously important such events are to the populace at large, and which therefore become highly prone to affect the thinking of many investors. According to Jeremy Grantham who many resources refer to as a "legendary investor": "the ebb and flow of economic and political news is irrelevant" (italics added), and further, "do your own simple measurements of [stocks'] value, or find a reliable source.” In other words, the key to successful investing is to recognize periods where valuations for stocks are either low or high; right now, most analyses, including my own, indicate that they are still on the somewhat low side.
But before we conclude, we would be remiss if we did not point out that gains in any index which exceed 25% might be interpreted as a sign to temporarily reduce one's exposure to stocks upon seeing the rises which have already occurred, as described in my Feb. 2010 Newsletter. Since stocks do not go straight up indefinitely, it may be safer to sell a small amount of one's position, say 5% or so, after such a rise. While the bull market may go on, you will record some gains and possibly protect yourself in the event of a likely inevitable correction. Likewise, investors may want to wait for pullbacks before making new stock investments from here on out. Of course, if one does not wish to be ever alert for such happenings, merely maintaining one's maximum level of comfortable exposure to stocks in your asset allocation in the recognition of current bull market conditions can also be a winning strategy.
Continue on to Lessons From the Ten Year Treasury Benchmark by Steve Shefler