David Weidner’s Writing on the Wall – July 8, 2014, 6:16 a.m. EDT
Opinion: Since 1929, stock-market rallies have had things in common that this one doesn’t
SAN FRANCISCO (MarketWatch) — Today’s bull market is the fourth biggest since the 1929 crash after stocks have nearly tripled since the financial-crisis low set in early 2009.
But more than any modern bull market, this one stands alone in that it’s squarely out of step with economic growth. It’s being driven higher by just a few wealthy participants and traders who have tacitly, perhaps even unknowingly, agreed to drive prices higher.
The main reason for that is two-fold.
First, low interest rates have made other investments unattractive. The 10-year U.S. Treasury /quotes/zigman/15866666/realtimeBX:TMUBMUSD10Y-1.74% is yielding only 2.62%. Inflation is running at an annual rate of 2%. That makes corporate bonds, certificates of deposit (which yield less than T-bills) and other fixed-income products largely a losing proposition. Those who have been buying bonds have been doing so for safety.
Second, the investing public isn’t really buying stocks. A study by the Pew Research Center, published in May, found stock ownership by households is shrinking, at 45%, down from more than 65% in 2002. Even with the Dow Jones Industrial Average /quotes/zigman/627449/realtimeDJIA-0.56% reaching the 17,000 milestone, investors are leaving stock mutual funds, not buying them.
This series of circumstances is unique. Unlike central bankers’ response to the Great Depression, the Federal Reserve has embraced Keynesian economics and flooded the economy with dollars on a scale never seen before. The Fed’s balance sheet has more than quadrupled to $4.3 trillion since 2008.
In short, stocks have become more attractive not because of a surging economy or strengthening corporate profits, but because they are the last-place finishers in an ugly contest. That’s a significant difference with boom markets of the past.
For instance, between 1935 and 1937, the stock market lagged an economic recovery. U.S. gross domestic product rose 10.8% in 1934 and 8.9% in 1935. But stocks only took off in that last year, eventually logging a 132% increase until 1937. In that last year, economic growth was robust, but it came crashing down in 1938. GDP contracted 3.3%, and deflation added to woes, with prices falling 2.8%.
The next long-term bull market occurred from 1942 to 1946, when stocks jumped more than 150%. That isn’t a good comparison, given the nation’s involvement in World War II. But there were some robust years economically. And once again, the market moved along with the economy: a 17.7% growth rate in 1941, followed by 18.9% in 1942, 17% in 1943 and 8% in 1944. Much of the growth was offset by inflation (9% in 1942), but at least investors had a reason to buy.
The first post-war bull market began in 1949 and lasted nearly seven years. Stocks rose more than two-fold as U.S. GDP grew at least 4.1% in each of those years, including an 8.7% growth rate in 1950. The Dow Jones Industrial Average finally passed its 1920s record high in 1954. Inflation was all over the map. Prices rose 8.7% in 1951, but increased at about 1% or lower between 1953 and 1956.
The mid-1980s bull market saw stocks, as measured by the S&P 500 /quotes/zigman/3870025/realtimeSPX-0.52%, double during a five-year period beginning in 1982. Like the current bull market, gains were made to seem bigger after the S&P 500 dropped to only 102.42 in the summer of 1982. But again, there was economic growth that exceeded historical levels — between 3.5% and 7.3% during the rally — and inflation and unemployment fell during that time.
Some describe the period from 1987 to 2002 as a bull market. Technically, it may be. It rose more than 500% during that span. But the real bull market of this era occurred between the start of 1995 until early 2000. Stocks in the S&P 500 rose 237% as GDP increased between 3.8% and 4.8% annually. Inflation was low, between 1.6% and 3%. Unemployment fell each year, starting at 5.6% and ending at 4%. Yes, some of this gain was fueled by unrealistic expectations about dot-com companies, but there was real economic growth underneath it too.
In all of those periods, the market reflected strong economic trends: solid growth, high or strengthening employment and stable inflation. Only the latter is present today. The unemployment rate is improving, but it’s still a relatively high 6.1%. The best GDP rate produced since the financial crisis was 2.8%. That was in 2012, before the current bull market really took off.
Perhaps, as some suggest, this is a new normal. If so, it represents a disconnect between economic reality and market valuation. More likely, it’s a warped market distorted by the extraordinary measures used to create an economic lift.
As market indexes touch new highs, investors should ask themselves if they’re taking part in a history-making rally, or a rally that is ignoring history.