A new all-time high doesn’t mean stocks are as close to a peak as this climber. Source: Buena Vista Images/Getty Images.
Markets returned to all-time highs late last week, with the S&P 500 and global markets each notching new records. They had new company in record territory, too! The NASDAQ, after a 15-year hiatus, closed above 5,048 to set a new record. While coverage includes a fair dose of rationally sanguine articles noting today’s NASDAQ is a far cry from 2000’s frothy gauge, others suggest stocks are pricey and risks abound. Still others just note both sides with confusion. You can put us squarely in the non-bubble camp. In our view, most bearish arguments surrounding Tech bubbles today are mostly another example of acrophobia in action. While we are sure this bull market will eventually peak,[i] we see little suggesting recent record highs are the top.
Stocks routinely trade in uncharted territory as bull markets mature. By now, we figure you know this. After all, Friday’s was the S&P 500’s 146th record in this cycle. The MSCI World’s 84th. During the 1980s the S&P 500 reached 153 all-time highs. In the 1990s’ bull, 347. Pundits fretting mean reversion or other pessimistic arguments because stocks are near their highest point to date forget that more often than not, those highs aren’t the peak.
This doesn’t mean bull markets always run long into uncharted territory. They don’t. The S&P 500 total return index hit just 46 new highs during the 2002 - 2007 bull.[ii] The nearly five-year long bull market from 1932 to 1937 didn’t breech 1929’s high once. But fundamental factors caused both. The 2007 bull market was quashed by the massive unintended consequences of mark-to-market accounting on banks’ balance sheets and the government’s messy attempts to deal with the fallout. 1937 ended after the Fed hugely increased reserve requirements. Which makes the point: However far a bull runs, it has nothing to do with price level attained.
Index levels are merely the product of past movement. Stocks are not serially correlated or subject to laws of physics like momentum because stocks are forward looking, moving most on the difference between those expectations and reality. Yes, this bull by definition will die at a peak. But it won’t die because of the peak—bull markets exhaust when reality can’t live up to sky high expectations or die early when walloped by some big, unseen, powerful negative like 2007.
Still, investors often fear markets breaking new ground because they too literally interpret the phrase, “Buy low and sell high” to mean “don’t buy at a record high.” However, if the record is, say, #146 of the 1990s’ 347, did you buy high or low? Considering that occurred September 12, 1995 and the S&P 500 rose another 188% before peaking in March 2000, we’d argue that record high was actually low. Fear of heights may be rational if the high thing you fear is a really, really tall ledge without a railing, but applying it to financial markets is dangerous. It often causes investors to avoid stocks long before bull markets end, leading them to miss out on market returns over time. Miss enough growth, and you risk missing your long term goals. This is why overcoming your brain’s tendency to lead you astray is vital to successful investing.
Today, stocks are near all-time highs, but fundamentals and sentiment point to more bull market ahead. Overall equity supply is shrinking as share buybacks and cash-based M&A outstrip new issuance. And the IPOs coming to market are mostly from fairly high-quality companies. IPOs during euphoric periods like 2000 tend to be mostly junk—companies with shaky business models relying on cash injections from capital markets to survive.
Yield curves today are positively sloped, and The Conference Board’s Leading Economic Indexes for most major economies point to growth ahead. The US gauge hasn’t fallen in the last 14 months and, since 1959, no US recession has begun when LEI is rising. Forward-looking new orders components of the US ISM services and manufacturing indexes suggest growth ahead. Ditto for services and manufacturing indexes across Europe. Now, those predict economic trends, not stocks. But, stocks being a forward-looking economic gauge, the fact a recession is unlikely ahead mitigates one major negative.
Politics, too, point positively. Last year’s US midterms extended gridlock in Washington, reducing the chances of radical legislation potentially walloping the bull passes. With 2015 being the third year of President Obama’s second term, most politicians are more interested in next year’s presidential race than in passing laws affecting property rights or other issues affecting stocks. This is why Presidential third years are historically the best of the four-year cycle, with only two negatives since 1926 (both in the 1930s) and 18.5% average S&P 500 gain. Competitive nations elsewhere are bullishly gridlocked, too: The UK, which has its own election approaching, is gridlocked and looks to get more. France, Germany and Australia also face governments lacking the ability and/or willingness to pass material market-loathing laws.
Lastly, while yes, more investors aren’t nearly as irrationally fearful today as they once were, neither are they irrationally exuberant. Valuation measures are above average, but not hugely so. Fund flows don’t show a flood of money into stocks. Margin debt isn’t spiking higher. You just don’t hear folks commonly suggesting we’re in some new perma-bullish reality. Euphoria’s typical traits are absent.
That warming-but-not euphoric sentiment, economic fundamentals and gridlocked governments point to rising stocks ahead is much more indicative of future market direction than an index level, record high or no.
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[i] And it will probably end badly, because bear markets follow bulls and they are bad.
[ii] Global gauges and foreign went far further into record territory, which highlights another problem with assuming all-time highs predict market direction: Which index do you choose?