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A Pause that Refreshes or Trouble Ahead?

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In part one of our quarterly recap we looked at the bumpy ride over the last three months and we saw how a disciplined approach paid off. Now let’s look at two common questions investors are currently considering. The questions are:

  1. The market’s had a good run since 2009, so how much longer can the recovery last?
  2. But, the market’s also gone nowhere over the prior 15 months. Does this spell trouble for stocks? 

I decided to run the numbers to assess these questions. The bulk of this article will highlight the findings and highlights the data. But first, here’s a quick summary for those pressed for time or who don’t want to weed through all the charts.

How much longer can the recovery last?

  • First, we don’t know and can’t predict the future, but in terms of either length or valuations, the current market isn’t a huge outlier. On a relative basis—using earnings yield to compare stocks to Treasury yields—the market still looks pretty attractive.
  • Based on history, the market can continue to rally much longer than we think (we are on day 2,579 without a 20% correction since March 9, 2009).
    • The other two market rallies which extended past 2,000 days (starting in March of 1980 and May of 1993) returned 12.5% and 13.0% annualized returns over the next five years (1825 days) respectively.
    • Over the next decade, the annualized returns were 19.6% and 7.5% (again starting in 1980 and 1993 respectively). This latter period includes the 2000 “Tech Bubble” and it still managed to produce a 7.5% compounded annual return—which doubled your money over the decade.
  • So, just because we’ve had a long rally it doesn’t mean we are necessarily due for a bear market.

Next, does the fact that we haven’t made a new market high in the last year or so spell trouble for stocks?

  • Periods like the current one (216 days since the last high for the S&P 500) are pretty normal.
  • According to Bloomberg, since the 1930s, “seven bull markets have witnessed rebounds [meaning the rally continued] from lulls that lasted longer than the current one.”
  • If we look at periods since 1950 where the market went at least 150 days without making a new high, we find:
    • If the market remains in a bull market, returns over the next 12 and 24 months are favorable (13.6% and 26.1% respectively vs. 8.8% and 18.1% for all 12 and 24 month periods).
    • Interestingly, even if we look at all periods where the market failed to make a new high for 150 days (these included both when the market remained in a bull market and those that fell into bear markets), the market, on average, was up 3.2% over the next year and 21.7% over the next 24 months. 

How long can the recovery last?

Since March 9, 2009, through the end of Q1 2016, the S&P 500 has gone 2,579 days without a drop of at least 20%. This is the second longest streak without a 20% drop since 1950.

To address the question of how much longer the rally could last, I decided to run the numbers and see how this market recovery stacks up to prior recoveries (all data via Yahoo Finance which goes back to 1950).

First, in judging by the calendar this has been an above average recovery. It’s about 1000 days (2.7 years) longer than the average bear market recovery.Days.jpg

But, regarding total return the current recovery ranks third greatest and is only 20% above average (granted, this average is skewed by the rally into the 2000 market peak).Total_Return.jpg

Looking at annualized returns, to account for both the length and magnitude of the rally this recovery, the current recovery ranks only 5th—about 7% below average.


Next, looking at valuations, we typically use the Cyclically Adjusted Price Earnings Ratio (CAPE).[1] By this measure we are currently at the 3rd highest PE ratio for the end of a market rally and 10% above the average ending PE.PE_Ratio.jpg

But a potentially just as important valuation measure, given the low-interest rate environment, compares the Earnings yield (Earnings / Price) to the yield on a 10-year Treasury bond. For example, if the aggregate earnings on a stock index were $5 and the price for that index was $100, the earnings yield would be 5% (5/100). And if the yield on a 10-year treasury were 2%, the EY spread would be 3%.EY.jpg

Again, this measure is particularly interesting now with low yields on bonds and the need for investors to be invested somewhere. By this measure, the current spread to Treasuries is the most favorable, by a wide margin of any ending value for a market recovery. Currently, the earnings yield on stocks is 1.9% over treasuries while most (seven out of nine) recoveries ended with the earnings yield on stocks being less than Treasuries stocks (-1.2% average). Using the earning yield spread metric, the stock market looks pretty attractive when comparted to the alternative or bonds.

And here is all the data in table form.Market_Recoveries.jpg

While there are no obvious answers from this exercise, I think it does highlight that the current recovery isn’t by all measures long in the tooth even though it’s now the second longest rally on record. 

The Market is Going Nowhere

The next question that gets asked comes from the frustration of the market going nowhere over the last year or so.

Here’s a chart from author Ben Carlson’s recent post titled “We’re in a Bunny Market.” As you can see over the last 15 months, the S&P index has bounced around plenty, but it’s produced a return that is pretty close to zero. The term “Bunny Market” is used to describe this period in the market—one that’s neither up big or down big, but simply hops around a lot.q1_chart1.png  

According to Ben, since these markets can be frustrating they can lead to unforced errors—invetors simply trying to make something, anything, happen.

But, these “Bunny Markets” aren’t all that uncommon nor do they necessarily spell trouble. According to Bloomberg “Since the Great Depression in the 1930s, seven bull markets have witnessed rebounds from lulls that lasted longer than the current one -- often a lot longer. The average gain in the 12 months after: 24 percent.” 

To further get a sense of what happens after a long pause in the market, I looked at each Bear market recovery going back to 1950 (daily data available via Yahoo Finance). Specifically, I looked at periods when the market went more than 150 days without a new all-time or recovery high; there are nine such periods.

I found that when stocks remain in a bull market, returns over the next 12 and 24 months were favorable (13.6% and 26.1% respectively vs. 8.8% and 18.1% for all periods).

Interestingly, even if we look at all periods where the market failed to make a new high for 150 days (these included both when the market remained in a bull market and when it reverted to bear markets), the market on average was up 3.2% over the next years and an above average 21.7% over the next 2 years.Long_Pause.jpg

While these extended periods when the market fails to make new highs and it seems like it’s going “nowhere” are frustrating, it doesn’t appear these long pauses spell doom for stocks. Instead they can be the pause that refreshes.




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[1] A PE ratio compares the current price to the level of earnings and essentially tells you how much you pay for each dollar of earnings. And the CAPE ratio, developed by Nobel Laureate Robert Shiller, uses the last ten years of earnings, in current dollars, averaged over the last ten years.

Click here for disclosures regarding information contained in blog postings.
Cordant, Inc. is not affiliated or associated with, or endorsed by, Intel.

Published on April 13, 2016

Isaac Presley, CFA

Isaac Presley, CFA

Isaac Presley is the President and Director of Investments for Cordant, a wealth management firm serving current and former Intel employees. To learn more, you can read Isaac's full bio.

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