Has This Rally Only Just Begun?

Feb.10.11 | About: SPDR S&P (SPY)

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” -- Sir John Templeton

Even though stocks have been rallying for almost two years and the Standard & Poor’s 500 index has nearly doubled, many investors don’t think we’re in a bull market.

It’s all an illusion, powered by the Federal Reserve’s printing presses, some worry.

It’ll come crashing down as soon as the world realizes the U.S. is broke, others warn.

Or — more commonly believed on Wall Street — it’s just a “cyclical bull” in a long-term “secular bear” market, and we’ll never recapture the highs set in October 2007.

But what if this is actually an extended bull market that no one saw coming — like, say, that of the 1990s?

What if U.S. stocks still have a long, long way to go for a long, long time, and we’ll understand the reasons only later — too late for most of us to make money on it?

This is not necessarily my view (which I’ll share later), but that of one of the most respected market analysts around.

Laszlo Birinyi, founder and president of Birinyi Associates in Westport, Conn., is best known for his appearances as a panelist on Wall Street Week with Louis Rukeyser back in the day. He focuses like a laser on market history, discerning patterns and parallels where the rest of us see only random data points.

Birinyi called this a bull market early in its move in 2009. And he stunned investors in January when he contended that if this bull stayed true to historical form, the S&P 500 could hit 2854 -- more than double the current price -- by September 4, 2013.

Since then, Birinyi has trimmed his sails a bit. In a report issued Monday, he called 2800 the “best case,” but thinks that under a “more probable” scenario, the S&P would hit 2100 by 2013. His “worst case,” S&P 1750, would still be an all-time high.

So he’s looking for this bull market to rack up 162-210% gains from the March 2009 lows. That would put it among the top-performing bull markets of the past 50 years, as the table illustrates.

Stock Performance in Previous Bull Markets
% Gains in Standard & Poor's 500
Total % Total
Bull Market 1st Quartile 2nd Quartile 3rd Quartile 4th Quartile Gain Duration*
1962 34.0% 14.9% 8.3% 7.8% 79.8% 1324
1974 61.6% -8.3% 6.6% 42.8% 125.6% 2248
1982 62.6% 9.0% 32.2% 40.3% 228.8% 1839
1990 43.1% 12.2% 39.9% 78.7% 301.7% 2836
2002 45.7% 4.4% 7.1% 23.7% 101.5% 1826
2009 79.9%
Average** 49.4% 6.4% 18.8% 38.6% 167.5% 2014.6
*Calendar Days
**Does not include 2009 bull market
Source: Birinyi Associates, Inc.
Click to enlarge

Birinyi doesn’t look at GDP growth, earnings, or P/E multiples. He came to his conclusion -- which he says is not a “prediction” but a “roadmap” — by studying previous bull markets.

What impressed him most, he told me in an interview, was the strength of this bull’s early move.

“This bull market has the strongest start of any in history,” he said. “When you have a very sharp rise in the first part of the bull market, those tend to be prolonged bull markets.”

In the roughly 410 calendar days between the March 9, 2009 lows and the April 23, 2010 peak of 1217, the S&P soared nearly 80%. Birinyi called that the first phase, or “quartile,” of the bull market. Prolonged bull markets, he said, have four phases, roughly corresponding to four stages of investor sentiment.

He calls the first phase “reluctance,” which is followed by “digestion or consolidation,” then “acceptance” as investors start believing in the rally, and finally “exuberance.” (See the Templeton quote above.) Any resemblance to Dr. Elisabeth Kubler-Ross’s five stages of grief is purely coincidental.

According to Birinyi, the first and the fourth stages are historically the strongest. The second quartile, which we’re in now, is usually the weakest, as the market consolidates. It averages only 6.4% gains. As of Tuesday, the S&P had risen 8.8% from last April’s high. He expects this phase to continue until midsummer, so it could have better-than-average gains, too. Or we could see another correction that brings it closer to the average for this phase.

Oh, and by the way, Birinyi has no doubt this is a real bull. “We believe that the current experience has the characteristics of a long-duration, secular bull market (low multiples, excessive negative attitudes, strong start) …,” he wrote. He thinks this one will last 1,640 days, or about 4 ½ years — which would take us into September 2013.

Birinyi Has Good Company

Birinyi’s “roadmap” is bold, and if it weren’t for his reputation, some people might call him crazy. But he shouldn’t be dismissed, even if you’re still bearish. Back in the 1990s, another notable analyst, technician Ralph Acampora, went way out on a limb and predicted first that the Dow Jones Industrial Average would reach 7,000 and then 10,000.

Incidentally, Acampora has come out of retirement and is working for Altaira Investment Solutions, based in Switzerland. “We believe that the bull market that commenced in March 2009 is still in force and has further upside potential,” he wrote recently. “ Our overall conclusion is not consensus opinion but, as contrarians, we feel comfortable with our minority viewpoint.”

His “potential upside target” for 2011: Dow 14,402 and 1563 in the S&P, above or close to their October 2007 all-time highs. He didn’t say how high stocks could ultimately go.

Another noted technician, Ron Meisels of Phases & Cycles in Montreal, shares Birinyi and Acampora’s optimism. He, too, called for Dow 10,000 in the 1990s, and thinks we’re now in a secular bull market that could last for years.

“What we have seen in the last few months can be viewed simply as growth in bull market recognition – not the type of excess that usually characterizes major market tops,” he wrote recently.

“All the other interpretations – particularly, that the past 22 months have been a glorified bear market rally – have fallen by the wayside.”

As for me, I’m a skeptical optimist. This bull market has surprised many people by its strength, including myself.

I expect to see a market correction this year, much like the one in 2010, probably tied to a crisis in Portugal or Spain.

But with U.S. economic growth picking up steam and the Federal Reserve unlikely to raise rates anytime soon, I don’t see why this market couldn’t move much higher over time.

Sam Stovall, chief investment strategist for S&P Equity Research, is predicting $96 a share in S&P 500 earnings this year. A reasonable 15x those estimates gets us to S&P 1440. Assuming earnings growth slows to 5% annually for the next two years, a 15x multiple would give us an S&P of 1587 by 2013—a record. (Here’s Stovall’s take on where stocks could go from here.)

But greater optimism usually ushers in higher multiples, so Birinyi’s “worst case” of 1750 doesn’t look so outlandish. Meanwhile, the idea that U.S. stocks could go much higher certainly isn’t in the market's or in investors’ expectations.

This is not about outguessing the market. But it is about sticking with stocks, assuming your equity allocation is where you want it to be.

“The real point is, don’t get rattled, don’t get shaken out; this is a long-term rally,” Birinyi told me.

Sage advice, no matter where you think the market will be a year from now.