In the last few weeks, as the S&P 500 (SPY) went ever higher, the question made itself more and more relevant: Is this the start of a new bull market? It's not hard to come to that conclusion, charts such as the ones below make it seem quite possible (Source for second chart: "Is the secular bear market ending for stocks?" - Fidelity):
So, is this really the start of a new huge up leg in the market? Are the current highs to be seen as a huge buying opportunity down the road? This article seeks to answer those questions by comparing where we stand today with where we stood at the start of the previous bull run (from 1983 to 2000).
Long-Term Interest Rates
At the start of 1983, 10-year treasuries were yielding a lofty 10.5%, having fallen from even higher rates, 14-15%, 6 months earlier. These were generational highs for interest rates, as we can see in the chart below.
Over the next 30 years, rates would drop from these levels all the way down to the present 2% levels.
Today, instead of being near a generational peak in long-term interest rates, it's quite a bit more likely that we're near a generational low. 10-year interest rates stand at 2.10%, having climbed from 1.6% 6 months ago after being as low as 1.4% nearly one year ago.
It's not likely that a bull could be fed on declining interest rates over the next couple of decades, as the previous bull was.
At the start of 1983, we were around 3 years into Paul Volcker's reign at the Federal Reserve. Having pushed the Federal Funds rate all the way up to 20% in June 1981, Paul Volcker had broken the back of inflation, which stood as high as 13.5% in 1981 but as of 1983 was already sown into the low 3% area.
As the generational bull market got underway, the Federal Reserve was already embarked on a generational lowering of the Federal Funds rate, as we can see below. Coming from incredibly high levels, this drop would last for decades:
Today, the Federal Funds rate stands at 0%. Not only does it stand at 0%, but the Fed is embarked on a printing campaign by the name of quantitative easing.
It's not likely that a bull market can be fed on declining short-term rates when these rates start from a level of zero. However, as we'll see later, it's not impossible to feed the bull on something else.
As a proxy for valuation, I will use Shiller's Cyclically-Adjusted Price/Earnings ratio (Source: Online Data Robert Shiller).
At the start of 1983, Shiller's CAPE stood at 8.5. As we can see below, that was near a generational low.
Today, it stands at 23.2. While not a generational high, for it went as high as 45 during the dotcom bubble, it's still well above historical norm. One cannot easily expect an expansion of the earnings multiple to drive a renewed long-term bull market, not unless one expects another bubble.
I've already covered this particular variable in my article "Where's The Bubble?" But for completeness, here we go. At the start of 1983, corporate after tax profits as a percentage of GDP were around 4%, well below historical norm. Although they'll still see a further dip, most of the following decades will see higher and higher corporate profits as a percentage of GDP, as can be seen below.
Today, corporate after tax profits as a percentage of GDP stand at an historical high of around 11%. Not only that, but profit margins tend to be cyclical over time, so standing so high above norm is a powerful headwind.
It's not likely that a bull market can be fed on expanding profit margins.
From what I have shown, it's easy to conclude that it's not likely for a long-term bull market to start from where we stand today. However, this is where I will make an exception. While it's not likely that in a rational and cautious world such a bull market might take place, it's not impossible either.
There is one entity, which could, if it disregarded everything else, produce such a market. This entity is the Federal Reserve. Were the Federal Reserve to print enough money and buy enough assets, and no matter what the fundamentals are, this is what could take place (Source: Whendoyouskipgold.com):
So the Federal Reserve can manufacture a stock market bull market of any size at any time and under any circumstances/fundamentals. That's the wild card.
There is little reason to believe that a new generational bull market is starting from today's levels. Every piece of fundamental data argues against such a conclusion. However, there is one wild card, which could produce such a bull market at any time, under any set of fundamentals - the Federal Reserve's printing just like it's doing today, going forward.