Is a review of the last 130 years of S&P history worth it? Based on a very strong statistical correlation between market movement in the first and second half of this time window one would conclude that while history may not exactly repeat itself, it certainly rhymes. Looking for those rhymes and the reasons over the prior 130 years sheds light on the S&P direction for 2014.
The S&P has traveled within a fairly narrow price channel over time, with the exception of two highly volatile 13 year windows namely 1927-1940 and 1998-2011. Both of these windows began with market excesses identifiable in the chart below by their extreme divergence from the long-term trend line. In both cases over the following 13 years their contractions were precipitated and then stabilized by extensive central bank monetary actions. We all know about the QEs of 2008 through 2013, but did you know that from 1928 to 1929 the US Fed actually implemented an oppressive tight money policy to bring-on the 1929 crash by sharply raising short-term interest rates, creating an extreme inverted yield curve. They then allowed the money supply to contract at a rate that approached 60% creating a deflationary spiral that took years to reverse. These actions were and still are unparalleled in their magnitude and impact.
It's no wonder the 1929-1932 crash was so severe given the extreme tight monetary policy impacting on the economy and investors during this period. It is also not surprising the massive recovery in value during the 50's and 60's given the Fed reversed its position and initiated the longest period of quantitative easing in history that started in 1935 and continued through to 1947. We have seen similar "accommodative" actions by the Fed since 2008 and with similar positive results to date. So what will happen going forward as they taper the money supply expansion while maintaining low interest rates? Some say we will see a substantial period of churn in the markets, while others see continued growth. If history repeats itself, they are both right. During the money growth tapering window of the late 40's the market did pause, traveling through a series of corrections from 1947 to 1949. However, this was only a pause in the longest, most extensive bull market in S&P history from 1932 to 1973. This growth period of course includes the post-WWII period during which the USA was the manufacturing powerhouse of the world and energy costs were relatively low.
Robert J. Shiller's Stock Market Data Used in "Irrational Exuberance" Princeton University Press, updated
There are two black colored linear trend lines on this chart, one showing the trend over the full 130 years and the other only for the last 73 years from 1940 to today (the section of the S&P history shown in red). These two lines have somewhat different trajectories and so have been diverging since 1980. The red and green lines running in parallel with each of those two trend lines mark the outer edges of the S&P's travels over time. They are data bands or channels, each containing 99% of all S&P data points within their respective time windows. The current S&P level has risen steadily since its bottom in March 2009 from a point right at the edge of the 73 year channel lower band to its current level located about 1/3 of the way across the channel, or ½ way across the 130 year price channels range. It is currently positioned between these two trend lines, and not near the upper edge of either's trading channel. This suggests there is still substantial room for the S&P to expand before slowing its pace of growth. We will have several years more of strong growth if history repeats itself.
Looking at the cyclicality of the market, since 1940 the S&P has gone through two 34 year cycles. The rate of growth from the start to the end of each of the two cycles is exactly the same. The amplitude of each wave is almost the same; however, the volatility at the end of the second cycle from 1998 to 2010 is much greater perhaps due to the hands-off stance taken by the Fed under Alan Greenspan during the first half of that period. If history repeats itself, for the next few years we are still in the faster rising portion of a new 34 year cycle which started in 2010. Global "accommodative" money supply, low inflation, improving trade and capital account imbalances, improving sovereign and corporate balance sheets and energy cost stabilization trends do support this projection for at least the near term of 2014-2015.