We are currently in the longest bull market ever.
What is a bull market? It is when the stock market rallies beyond 20%. This week, the current bull market turned ten-years old. March of 2009 brought the Dow Jones Industrial Average to a low of 6,500 points. This was roughly six months removed from the Lehman Brothers bankruptcy that sent the US economy into the Great Recession via the Financial Crisis. The market had initially bottomed around Obama’s victory in November of 2008 around 8,000 points, rallied beyond 10,000 points, until a volatile February sent investors reeling again. A lot has changed in financial markets since those dark days. Maybe, so much change that the stock market may never experience a cycle like that ever again?
There were a lot of tools implemented throughout the crisis, and one term that was thrown around a lot was Moral Hazard. Think of moral hazard like this. Your child acts out and throws a fit, so you offer him a cookie. He continues his tantrum, so you give him the iPad to hush him up. The child has now become conditioned to act in negative fashion to receive positive rewards. This is similar to Pavlovian Conditioning in regard to dogs and rewards. Why is this relevant with financial markets? Companies, as well as consumers were bailed out by the Federal Government, and Federal Reserve. The bills legislators passed, such as TARP and HARP, bailed out over-leveraged companies, and debt-burdened consumers. The programs referred to as Quantitative Easing and Zero Interest Rate Policy or QE and ZIRP were new techniques implemented by the Federal Reserved that helped calm, and subsequently prop the markets.
All four of these programs helped aid a market in need. Sounds a lot like that crying baby getting a cookie, doesn’t it?
Consider three reasons that US markets will avoid a prolonged, future bear market, or 20% decline.
Reason One: To what extent will legislators and the Federal Reserve actually allow markets to fall next time we enter a downturn?
Think about it. We have seen our president publicly pressure and complain about our current Fed chair. We have seen legislators campaign on promises relevant to the stock market and the economy. The financial markets and Federal Reserve are tied together, and legislators have joined in on the marriage to make it a playful threesome. The grouping appears unbreakable. It seems unlikely politicians would idly sit back and watch the market fall without providing action. The same is true for Presidents now, and in the future. The Fed chair will face amazing pressure the next time the market sputters long term.
Reason Two: Technology has revolutionized finance, again, making a prolonged bear market unlikely. Two components within technology are important to understand.
Part 1 – The access and the transmittal of information
Our market is increasingly moving towards perfection, which in finance terms is referred to as the Efficient Market Hypothesis. There are many degrees of this, however, take note of the strongest degree.
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- The strong form of EMH assumes that current stock prices fully reflect all public and private information. It contends that market, non-market and inside information is all factored into security prices and that no one has monopolistic access to relevant information. It assumes a perfect market and concludes that excess returns are impossible to achieve consistently.
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Everyone is privy to the same information. This means there is minimal arbitrage; therefore, investors cannot capitalize on someone else’s ignorance. Look at it like this. Technology has enabled all traders access to the same information.
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- Twenty years ago, I may have acted on selling my stock in McDonald’s based on a hunch, whereas the person purchasing my stock actually knew relevant information to the long-term success of the company, therefore, capitalized on my lack of information. Today, we are equally able to discover this information. Nearly all company records are not only public, but readily accessible at the tip of your finger. No one is acting on inside information ahead of someone else. All traders are on the same playing field.
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- Part 2 – The way investors trade
Investors once purchased individual stocks, through stock brokers. The 1990s brought a rise in Mutual Fund investing, or the ability to have a fund manager purchase, and trade a basket of stocks for you. Online investing enabled traders the ability to do this on their own. Post-2008 the trend has moved to ETFs. This is a passive strategy. It means you buy the entire market, or a particular industry. For example, you buy a tech sector ETF, and instead of deciding how much Apple, Google, and Facebook you want, the ETF equally distributes the cash for you. There are no decisions made as to which tech company is better, the way a mutual fund, broker, or day trader invests. The full abandonment of picking and choosing.
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- This is relevant because if traders are not seeking out better investments, or speculating, then the market increases in efficiency. Speculation drives up the cost of a stock to an overpriced value, therefore, creating a bubble. Investors buying ETFs, and not individual stocks, removes the danger of speculative bubbles. As we learned in 2008, a bubble burst when too many investors crowd the trade – housing.
- This is relevant because if traders are not seeking out better investments, or speculating, then the market increases in efficiency. Speculation drives up the cost of a stock to an overpriced value, therefore, creating a bubble. Investors buying ETFs, and not individual stocks, removes the danger of speculative bubbles. As we learned in 2008, a bubble burst when too many investors crowd the trade – housing.
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Reason Three: Corporate America have never been more stronger.
US companies are more efficiently run than ever before. They have a multitude of resources on the technological side that they have adapted to increase the effectiveness of their business. They are largely protected from Black Swans, or unforeseen and unpredictable events, that can suddenly derail profits. US corporations have experienced a tremendous evolution through the adoption of technology. This adoption has not only made them stronger, but it has enabled them to hedge risk, and mitigate a future problem.
The simplest way to imagine why a black swan events is unlikely is to understand how they start. They are often caused by a lack of understanding, knowledge, or speculation. Technology, and access to information lessens those.
It is important to highlight the large issues facing the American economy, and how they may disrupt the bull market.
- Inflation
- Technology, and increased efficiency has drastically reduced the cost of most goods and services. This has largely resulted in the threat inflation to disappear. Think of airline tickets, gasoline, and the ability to have most products you need delivered to your door free of shipping.
- Technology, and increased efficiency has drastically reduced the cost of most goods and services. This has largely resulted in the threat inflation to disappear. Think of airline tickets, gasoline, and the ability to have most products you need delivered to your door free of shipping.
- America’s debt, and ability to fund our future liabilities – social security & healthcare
- This is our biggest domestic threat. It is a creation of our doing, but one we can fix if we elect politicians who have the courage to make necessary changes. It is the elephant in the room, and must be addressed sooner than later.
- This is our biggest domestic threat. It is a creation of our doing, but one we can fix if we elect politicians who have the courage to make necessary changes. It is the elephant in the room, and must be addressed sooner than later.
American companies, investors, money managers, politicians, and monetary chairpersons (Federal Reserve) have protected consumers from black swans, or events that can derail the market long-term. Access to information, a lingering moral hazard, efficiency amongst traders and within corporations have created the ten-year bull market Americans currently enjoy.
However, a black swan within our borders is most probable via an accounting scandal. Egregious errors were recently discovered at Kraft-Heinz, and General Electric presented investors with inaccuracies for years. These one-off events are OK, but can disrupt confidence in the market if a trend develops, like one did with Arthur Andersen in the early 2000s. This accounting scandal led to bankruptcies at Enron and WorldCom, as well as prolonged accounting issues at Merck and Tyco. Money has been freely tossed around for a decade. It is easy for regulators to get lazy in these times. Remember, when the tide rolls out, you discover who has been swimming naked.
The likely way the bull market gets shocked comes from abroad, and not in terms of war or terrorism. It is our companies global interconnectedness that present the biggest threat. All large American companies are dependent on profits from overseas. A scandal within another nation is one we cannot prevent. This likely has to do with cyber security and tampering. It would be something that suddenly disrupts global trade and connections with our partners abroad. American companies would surprisingly discover a nation playing by their own rules and would get caught. It would disrupt the flow of the supply chain and send an immediate shock into our system. Again, this seems unlikely, but it is potentially one of the few things that can disrupt the market.
- Potential examplesA newly elected populist leader drastically changing trade policies with America
- A group within a country disguises a massive cyber attack, leading the American government to believe espionage took place
- A revolt within a country suddenly disrupts stability, and forces our companies to rapidly exit
Remember this –
Had you timed the market perfectly, and sold everything at the highs in October of 2007, you would have been pleased with your choice until January of 2013 when the Dow officially recovered.
Since that date, the market has never looked back. Today, it is up 82% since that moment in January of 2013.
Phil Your Day 