July 13th, 2010
When we trade stocks, we think in terms of our own time line, in terms of our life time. We think of days, weeks, months and, perhaps for those of us who are patient, years. We hope to generate a profit over a relatively short time that we can then either pyramid into another successful trade or cash in to pay for a dinner, piece of furniture, vacation or school tuition. But the market’s internal time clock is much slower … actually, the market has no life, it’s infinite and it will outlive us all. So while years and decades seem like an eternity to us, to the market they are just one more phase it needs time work through. Take, for example, the last 25 years. It’s clearly divisible into two phases: the bull market of the 1980’s and 90’s and the secular bear market since 1999 (click on images to enlarge):
We all dream of the return of an investment environment like Peter Lynch enjoyed at the Magellan Fund between 1977 and 1990, when the fund had an average annual return of 29%. All he had to do, or at least that’s what he told us was to do, was to “buy What You Know”, and we too watch our portfolios grow. As we ponder to what levels the market might be head during the second half, the market might be contemplating where it might be headed over the remainder of this decade; I think I might have a clue.
I don’t know how many of you saw all the exposure Bob Prechter of Elliott Wave fame been recently getting (he even made the Sunday NY Times Business Section front page). Prechter, true to form as a perma-bear, reinstated his call for the next leg of this Crash to resume predicting it will be on a par with the 1929-32 Big One with the Dow-30, currently at 10198, “likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end.” But he’s been calling for a decline on that order of magnitude for what seems like years.
Contrasted with his pessimism (although he would probably call it “objective realism”), I’m more of an optimist and believe in a long-term “reversion to the mean” view of the market’s future. If you’ve been reading the blog since last year, you’ve seen several “reversion to the mean” charts. The concept relies on a statistically calculated 7.5% mean annual growth rate since 1939 in the economy and the market. The market index actually fluctuated within of band of ±40% around that statistical mean growth rate between periods of optimism (bubbles) and pessimism (crashes). Significantly, “reversion to the mean” accurately presaged the Financial Crises bottom in March 2009 as the Index touched but didn’t cross under the bottom boundary line of the channel at around 700.
Some compare the current Secular Bear Market since 1999 to the one in the 1970’s. The market made several attempts to advance above 100 in the S&P (1000 on the Dow) for about 12 years; it wasn’t until 1982 that it was able to move into new high territory. I’ve modeled a recovery from a similar low in the current Crash (March 2009) to where the S&P 500 Index might be in 2020 if it were to follow an identical path to the one it followed from 1975 when the Index last touched the lower boundary.
If the market were able to climb out of this secular bear market in a manner similar to the path out of the 1970’s one, then the S&P 500 Index could hit – are you sitting down – 3000 in 2020.
This is an extrapolation not a projection. It is based on the assumption that neither the long-term growth of the economy nor the stock market are doomed, they’re only on hold. To have them move ahead again requires changes in the near future different than but on the order of magnitude of those that helped bring the economy and market out of the cyclical bear market of the 1970’s (i.e., Oil Embargo end, Ronald Reagan, stemming high inflation, Iranian Hostage, etc.). The extrapolation assumes that the stock market will recovery haltingly over next few years, with an initial move to around 1250 followed by correction. Finally, a new bull market, based on new technological advances, more favorable national financial and economic conditions and strong political leadership could reemerge around 2013 and lead to, amazingly, an S&P hitting 3000 by 2020.
Pie in the sky? Perhaps, but that’s exactly how people felt and what they thought at the end of the ‘70’s and beginning of the 1980’s. But what’s more unreasonable or absurd: Prechter’s Dow 1000 (100 on the S&P) or the Stock Chartist’s S&P 3000 (or 30000 on the Dow)? Hope we’re all around in 2020 to find out.