About a month ago, in a Seeking Alpha article entitled "Return of Buy-And-Hold? S&P To 3000 By 2018", I wrote:
"Those who became investors anytime over the past 13 years know a market that is either in bear mode or one that is in recovery; they've never experienced a market that continually makes new all-time highs week after week, month after month.... We need a new metaphor to guide how we gauge how high "up" should actually be and to provide clues as to when we might be approaching a reversal."
Since 1939, the market has gained an average 7.5%/year; even after taking into account two 14-year secular bear markets and since 1939, it has stayed within the boundaries of a channel that is 45% above and below that 7.5% average annual rate of appreciation. I call it the "Reversion to the Mean" trendline. Using those boundaries as a guide, I can foresee the S&P 500 on a trajectory ending in the vicinity of the upper boundary of that channel, or 2500-3000, by the end of 2017-18, or almost a 100% gain from current levels over the next four years.
Crack open the champagne bottle because we haven't seen a "true momentum bull move" into new highs for 13 years (again, I consider the climb from the 666 bottom in 2009 a "recovery from a severe decline" rather than a "bull market"). While the "Reversion to the Mean" boundaries sets the long-term target, for the intermediate term, I turned to the exit from the 1970s secular bear market of 1979-82 as an analog for the exit from this Secular Bear Market.
The end of the last secular bear market saw inflation and unemployment skyrocket in the wake of OPEC's Oil Embargo, Volcker's Fed raised interest rates to unprecedented levels over 20%, and Congress enacted budget cuts and tax increases. The market took a 25-30% hit, which wiped out all the gains it had made since it broke above that upper boundary. The market only began to recover when these drastic steps were reversed a couple of years later.
The market's recent action in many ways replicates that breakout but, by contrast, the broader economic context in which the breakout occurred is almost an exact mirror image of that earlier period. As was true then, the market's next major turning point will depend on changes in three specific areas:
- Interest rates
- The exchange value of the $US and
- The inflation rate as reflected in the value of base materials, food and commodities and precious metals.
We are beginning to see asset prices rise in real estate and the stock market. It's only a matter of time (sometime in 2014-15, as the S&P Index (NYSEARCA:SPY) approaches the key 2000 milestone, 20% higher than current levels, and right on the Reversion to the Mean trendline) that we could begin to see prices rising in other asset classes. As the U.S. begins experiencing inflation, foreign investors might reverse their money flows and cause the dollar to decline in its exchange value. These forces could cause the Fed to respond in a panic by dramatically and rapidly raising interest rates.
[Note: While we celebrate and revel in the market's recent advances, we shouldn't be surprised or shaken out by the nearly certain test soon of the support capabilities of the previous all-time high that was recently crossed at 1565. That retracement could begin as early as the 1625-1650 area, only 2-3% above Friday's close. And when the market again touches 1565, many of those who missed the breakout the last time will use the decline as their final opportunity to then jump on the bandwagon before the advance quickly resumes.]