Several years ago we discovered I had a tendency of not wanting to admit we were wrong and found it stood in the way of understanding the situation we were engaged in. We spent more time defending and spinning our initial conclusion rather than quickly admitting our miss take. The stock market had something to do with the lesson as we found arguing with the market was hazardous to our wealth. The phrase “It is okay to be wrong, it is not okay to stay wrong” has made an impact on our learning curve personally as well.
We found the reason we were resistant to admitting we were wrong was that we thought others would think lesser of us, our critical thinking skills, and our credibility. After further review we found that the quicker we admitted a mistake the quicker the more relevant data was revealed. So the irony of the situation was that our critical thinking skills were actually being impaired because of our resistance to admitting we were wrong. The ego can play some interesting games and weave tangled webs, often below the radar.
Late last summer found the markets struggling and some less than stellar economic numbers being released. We were fairly convinced that the stock market would at best struggle as the headwinds of unemployment, state/federal/consumer/European budget deficits, and a host of other dynamics would thwart any decent rally. Wrong! Stocks took on the look of the Pamplona bulls, running through obstacles (negative news) with little respite. Outside of a short trough break in November the left to right 45 degree angle was nothing short of impressive.
Many, including ourselves, thought that the resiliency was due to the Fed’s QE2 strategy (providing a fire hose of liquidity) and soon that would end along with the rally. It is still a possibility, but in our estimation the constructive/productive nature of this equity rally has forced the question “Is this the start of a Secular Bull Market?” The last Secular Bull Market started in the summer of 1982 and most believe ended in the spring of 2000. The rally that started with the Iraq war in 2003 and ended with the Sub-Prime debacle in 2008 was considered a Cyclical Bull Market. Many still consider the current two year rally a Cyclical Bull and there will be another shoe to drop before we fully exhume the excesses of the past few decades.
We touched on this subject a while back and provided a table which showed the distinctions in several financial/economic factors that were in place in 1982 and recently. The few that stand out most notably to us are first interest rates, back in 1982 mortgage rates were above 15% and now they are below 5%, Treasury yields have similar spreads. Next was inflation; the seventies produced inflation rates that maxed out in the high teens, current inflation rates are less than 2%. Tax rates were significantly higher when Reagan took office, with the highest bracket near 70% on a marginal basis, and his administration reduced them considerably (and subsequently took back about half of them). Rates are currently averaging in the mid-thirties and we are not sure you can find anyone who thinks they are headed lower. These do not appear to be the dynamics that are the seeds of a Secular Bull Market. So what factors could be the impetus of a new Secular Bull?
Before we address that question we will say that there is a decided larger group that believes the economy and the markets face severe headwinds as compared to in 2007. Back then the worrywarts were dismissed summarily as being sour grape-ish because they missed the real estate boom. With only anecdotal evidence it appears to us now that the numbers have been reversed with more worrywarts than those with a constructive outlook. Remember the market’s tendency to make the majority wrong.
So if this is the early stage of a Secular Bull Market what might be the economic drivers? The most compelling demographic group we see in the current landscape is the growing middle class of the dozens of developing countries around the world. They are certainly attracted to the western style of life, which has been largely shaped by democracy and capitalism. Most economists will tell you that growing middle classes are economic engines. The decided advantage that this group has versus the growing US middle class in the latter half of last century is the access to incredible new technologies. The technology dynamic might be our economic savior as we provide the goods and services that help propel the economies of the developing nations. Could this overcome our interest rate, tax, and inflation issues?
Clearly quite a bit of conjecture here, but recent market action challenges us to step outside our cautious box. We subscribe to a fairly well known newsletter writer who has been more cautious than me the last several months. His latest missive continues to point to the headwinds and how a deep correction and possible crash will eventually occur. Unfortunately he gives no explanation for how and why he has been wrong for the past year. He may eventually be right (although we cannot imagine anything alarming occurring in the 3rd or 4th year of the Presidential Election Cycle), but we think he could benefit immensely if he would explain to his readers why he has been inaccurate.
If you have been cautious about investing in the stock market of late it is completely understandable considering the past decade. With the recent action this might be a decent time to re-evaluate your portfolio and determine if your cautiousness has created some lost opportunities? Certainly in the short term the information below probably points to higher prices, but then again we could be wrong.
Chart Spotlight
We mentioned above that several foreign markets have constructive chart patterns similar to the US indices. Below left is the chart of an Exchange Trade Fund representing an index of emerging growth countries (EEM).Last week the ETF broke cleanly above a six month base, a often very bullish pattern. The chart below is one that goes a little deeper in the weeds technically than we normally like to go in this space. It is of the New York Stock Exchange Summation Index Stochastic indicator (red/black double line) with the S&P 500 behind it. We do not want to get too much into details but what we are interested in showing is the relationship of the NYSI Stochastic to the S&P 500. As you can see each time the double line bottomed and turned around (green arrows), it was the start of a multi-week rally for the S&P 500. This indicator bottomed and turned up last week. The indicator does not work all the time, but since stocks bottomed in March of 2009 it has been a relatively reliable data point.
Did You Know
AND BORROW WE DO - The yield on the 10-year Treasury note was 3.29% on 12/31/10. The yield on the 10-year Treasury note was 5.12% on 12/31/00. Thus, for the same annual cost of money that our government would have paid a decade ago, we can borrow +56% more money today than we did 10 years ago. The US government paid $1 billion of interest expense on its Treasury debt every 31 hours during the month of February 2011. Total consumer credit nationwide (i.e., consumer debts excluding home mortgages and home equity loans) was $2.412 trillion as of 1/31/11, $35 billion less than the national total of $2.447 trillion as of 1/31/10. Although the $35 billion reduction sounds significant, it is equal to only $311 of debt reduction for each of the 112.5 million households in the country today. (source: BTN Research).
Final Thought
“Sometimes the questions are complicated and the answers are simple” – Dr. Seuss
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