Stocks: Catch This Bull Market At Four?

by: Eric Parnell, CFA

"Oh I'm on my way, I know I am, somewhere not so far from here
All I know is all I feel right now, I feel the power growing in my hair"

--Cat Stevens, Sitting, Catch Bull at Four, 1972

The bull market in stocks is now more than four years old. Since bottoming in early March 2009, the stock market as measured by the S&P 500 Index (NYSEARCA:SPY) has rallied a resounding +145% through Friday's close and is now +3% above its previous peak from October 2007. Given that 86% of investors are bullish on equities over the next six to twelve months according to a recent Barron's poll, many stock market participants clearly feel that they are on their way and feel the power growing in their hair. But following what has been a recent -3% pullback from its intraday highs over the last two weeks, it is reasonable to wonder whether it makes sense to remain sitting in the stock market or if the time has come to step aside.

The fact that the current cyclical bull market in stocks has lasted as long as four years is notable in its own right. Dating back to 1900, the stock market has fallen into a sustained bear market roughly every three years on average. Thus, the current bull market at 50 months and counting is already running considerably longer than most historically, as only six over the last 113 years have lasted beyond today's cycle. And once stocks have corrected following these past bull market runs, the duration of the subsequent bear markets have lasted more than 16 months on average with some running as long as three years. So while today's bull market did experience two brief shocks in 2010 and 2011, the duration of these declines were so short and the magnitude of these pullbacks so shallow that they hardly register in the historical context of past bear markets. In short, we are now long overdue for a sustained bear market in stocks after what has been a phenomenal post crisis run over the last four years.

The perpetuation of today's bull market represents the byproduct of what has been an ongoing struggle by policy makers to tame the global economy. Catch Bull at Four is a reference to one of the Ten Bulls of Zen Buddhism, which illustrate the stages of progression toward enlightenment. Catching the Bull, which is the fourth stage, represents the period of great struggle where the bull repeatedly escapes and discipline is required. And so it has been for major central banks as it relates to the markets over the four years since the outbreak of the financial crisis. Policy makers have struggled mightily to keep this current cyclical bull market intact, for anytime they have tried to advance to the fifth stage of Taming the Bull by applying less discipline and allowing the market to roam on its own, stocks almost immediately try to escape to the downside. The longer this struggle continues, the more unlikely it will become that this bull market will ultimately be tamed and transcended. Instead, it is more likely that a sleeping bear will finally be awoken. And the longer it is kept in hibernation, the angrier this bear is likely to be once it arrives.

"Where's it leading to? Freedom at what cost
People needing more and more and it's all getting lost"

--Cat Stevens, Ruins, Catch Bull at Four, 1972

The attempt to tame the stock bull market has come with great cost and potential risk. Since the outbreak of the financial crisis, the U.S. Federal Reserve has exploded the size of its balance sheet by nearly four times from just under $900 billion in August 2008 to nearly $3.4 trillion today. And at the current rate under its ongoing QE3 stimulus program, the Fed's balance sheet is projected to exceed $4 trillion by the end of this year and $5 trillion by the end of 2014.

But where is all of this money printing leading to and at what cost are we trying to achieve freedom for the stock market as a facilitator of the wealth effect to support economic growth? Investors are demanding more and more from the Federal Reserve as time goes by, but it is seemingly all getting lost at this point. For at one time several years ago the mere idea of quantitative easing was considered extraordinary, whereas today it is not only demanded by investors but the stock market also goes into a fit the moment policy makers merely mention the idea of cutting back on the amount of its asset purchases at some point in the future. All the while, the U.S. economy continues to sputter along with uneven growth that is slower in its rate of expansion than it was a few years ago and with many other parts of the world already decelerating or already in recession.

At some point, the efforts of the U.S. Federal Reserve will arrive at the point of diminishing returns where the next dollar of stimulus purchases no longer has the desired effect of sustainably lifting stock prices. While we have not arrived at such a juncture quite yet, we are increasingly likely to do so the longer the current episode drags on, as today's bull market is already well aged and is showing no signs of being tamed. And the greater the monetary firepower deployed today in trying to discipline the current bull market higher, the more unruly the subsequent bear market is likely to be once it finally emerges from its slumber.

In the meantime, the stock market continues to present selective opportunities. It should be noted, however, that current allocations should mostly be viewed with a short-term time horizon. From a fundamental perspective, the stock market lost its appeal a long time ago with effectively flat revenue growth over the past two years, annual earnings growth steadily grinding to a halt and forward earnings estimates in chronic decline for over a year now, as stock market gains over the last year and a half have instead been almost exclusively driven by multiple expansion. Instead, it is largely from a technical perspective and among individual names where stocks still have appeal.

At present, the stock market has shown support at two distinct levels. The first is at its 50-day moving average on the S&P 500 with a Relative Strength Index (RSI) reading just above 40 and an MACD reading in the 5 to 10 range. This has proven reliable support for stocks on a number of occasions since the beginning of 2012. It should be noted that we are currently still above such readings as of Friday's close, which is implied at around 1600 on the S&P 500, so further downside could be reasonably expected with the current pullback before this technical support kicks in. If this threshold were to break, the next support level resides at the 200-day moving average with an RSI reading below 30 and MACD readings at around -20. At present, this would imply the S&P 500 trading down to the 1475 range. If stocks continue to fall beyond this second line of defense, watch out below as the subsequent downside could be both severe and sustained. But in the meantime, stocks continue to enjoy solid support at some well-established technical levels. The important question looking ahead, however, is for how much longer given we are now well into the fourth year of a cyclical bull market.

As for individual names, a handful of high quality names that still trade at attractive valuations and provide healthy current income and set up well from a technical perspective continue to offer appeal. Representative names include ExxonMobil (NYSE:XOM), International Business Machines (NYSE:IBM), General Electric (NYSE:GE), McDonald's (NYSE:MCD), Emerson Electric (NYSE:EMR), Qualcomm (NASDAQ:QCOM) and Cisco Systems (NASDAQ:CSCO). Many of these also represent names with considerably less downside volatility that can potentially be held to maintain stock exposures through an ongoing bull market as well as through the worst of a bear market storm.

So while sitting in the current bull market continues to make sense for now, the current bull market at over four years old is becoming an increasingly undisciplined beast. As a result, it remains as important as ever to stand at the ready and to take action if necessary to avoid being caught up in the potential ruins that might accompany the next bear market.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Disclosure: I am long CSCO, GE, XOM, MCD, IBM, QCOM, ORCL, EMR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.