The Stock Market Economy

Currently, some market watchers have begun to openly question whether the bull market in stocks has finally come to an end. They certainly have cause to worry. Valuations are frothy after a record run-up in the last few years. Bond yields across the yield curve are rising sharply, as the Fed Funds Rate breaks into territory not seen since before the market crash of 2008. Much higher costs of capital are already putting pressure on rate-sensitive industries such as housing and autos. The boost to earnings provided by the corporate tax cuts will fade and rising prices resulting from past monetary policy and import tariffs may be expected to slow consumption and take a toll on balance sheets. All this points to possible lackluster performance, with stocks essentially flat so far this year.

But even while many expect a difficult period for stocks, we must come to grips with the fact that generations of investors have come and gone who have not experienced a grinding and protracted bear market. Such a scenario is unthinkable given the narrative to which these investors have been exposed. But the page may about to be turned and there are reasons to believe that the bill may finally be coming due.

Falling interest rates are generally regarded as good for stocks. Not surprisingly then, since Treasury bond yields began falling in 1982 (based on data from U.S. Dept. of Treasury), stocks have trended higher. The memorable declines that we have had since then, the Black Monday Crash of 1987, the sell off after the ’90 recession, the Dotcom and September 11 implosion of 2000-2001, and the Crash of 2008, were really just interludes in an otherwise surging bull market that has risen more than 30 times in nominal terms, according to data from the World Bank. In those events, the brunt of selling happened quickly and was over before investors really knew what had happened.

In ’87, a 35% drop in the Dow occurred in just 3 months, from August to October. In ’90 an 18% fall, also in 3 months, again from August to October. In ’98, the Russian economic crisis pushed the Dow down 18% in a month, from July to August. In all these instances, stocks made new highs within two years of the initial drop, in August ’89, April ’91 and January ’99, respectively. Entering the current century, the more difficult pullbacks have occurred, but were manageable nevertheless. Beginning in January 2000, the Dow dropped 35% over a period of 33 months. It then took an additional 4 years to make fresh nominal highs. In October 2007, the Dow began falling and plunged 53% in 16 months. But after that, stocks climbed steadily and made fresh highs almost exactly four years after the bottom. (Yahoo!Finance, DJIA interactive charts)