<<bear market that began in 2000 is not over - not by a long shot.>>
How Wall Street's false dawns prove blinding
By Maggie Mahar
Published: April 11 2004 19:36 | Last Updated: April 11 2004 19:36
news.ft.com
At the start of 2004, most US investors were convinced the bear was dead. Now, they are not quite so sure. It is not just that a rough patch in March all but erased the first quarter's gains. Nor is it that the bombing in Madrid, combined with an escalation of the war in Iraq, shook confidence. Without question, heightened global tension served as a catalyst for the market's tremors, but a catalyst is not a cause.
Seasoned investors worry that the market's slide points to a larger underlying problem. Those with a memory of what happens when a bubble bursts know that, if history is any guide, the bear market that began in 2000 is not over - not by a long shot.
In recent months, both Wall Street and Washington have been doing their level best to persuade investors that the bull is back and the economy is gaining traction. Despite the fact that job growth in the first quarter fell short of what would be expected in a normal recovery, President George W. Bush greeted the March numbers with a jaunty thumbs-up: his election depends on belief in the recovery.
Granted, the pundits and the politicians are willing to entertain the notion that this new bull market might be due for a "much-needed correction" of, say, 10 to 15 per cent. But few are willing to face the possibility that we are still in the early stages of what is likely to be a very long bear market.
How can one conclude that they are wrong? Because the US market has not yet "reverted to a mean". Past experience suggests that when a bubble collapses, a market cannot lay down a firm foundation for the next boom until the pendulum has swung back to its mean, or average price.
Historically, at its mean, the S&P 500 has traded at 17 to 18 times the previous year's earnings, and roughly 14 times estimates for the current year, while yielding dividends of about 4 per cent. When a bear market scrapes bottom, the pendulum inevitably swings too far in the other direction: price-earnings ratios usually sink below 10, while the yield rises to at least 5 per cent. Today, the S&P 500 fetches approximately 29 times last year's earnings and roughly 18 times estimated earnings for 2004, assuming you believe analysts' estimates. As for dividends, the average stock on the S&P yields less than 2 per cent. Meanwhile, the underlying economy deteriorates in what could be the prelude to a second fall in equity prices. Debt builds, the dollar declines, capital investment remains sluggish and, despite increased productivity, real wages barely budge. Sceptics argue that a recovery built on debt and consumer spending is no recovery at all.
There are precedents. Often, when a bubble bursts, the market crashes - and then rallies - before crashing again. Following a period of financial euphoria, it seems to take at least two sell-offs to break the last bull's heart.
So the crash of 1929 was followed by a 50 per cent rally. But then came the crash of 1930-1932. When it was all over, the market had fallen some 86 per cent from its pre-crash peak.
Similarly, the go-go market of the 1960s first sold off in 1970 when the Dow plummeted from a high of nearly 1,000 to a low of 631. Investors assumed that this was a nadir and, sure enough, late in 1970, the benchmark index began to climb. The bear market rally of the early 1970s ran for a little more than two years, reaching a climax early in 1973, with the Dow making a new high of 1,071.
Many thought that a new bull market had begun. Within weeks, the the crash of 1973-1974 began. When it bottomed, the Dow had sunk to 577 - seven points below where it had traded in 1958. An entire generation was driven out of the stock market. It would be another eight years before a new bull market began.
Does this mean that the US market is on the brink of a second crash? Not necessarily. History repeats itself, but always with a difference. This time the market could revert to a mean simply by trading sideways for eight or 10 years. Alternatively, it could follow the pattern laid down by the Nikkei: over the course of Japan's long bear market, investors have been tempted by rallies of 40 per cent or more on three separate occasions. In each case, only the nimblest - and luckiest - traders managed to hold on to a profit.
In the short term, it is impossible to know precisely what path a bear market will take. Over the long term, history makes prediction easier. In this case, past experience suggests that the bear is not dead, but hibernating.
The writer is the author of Bull! A History of the Boom, 1982-1999 (HarperBusiness) |
