The US stock market, as measured by the S&P 500 index, made a bottom at 102 on the 9th of August 1982. That is a level it reached for the first time on the 9th of July 1968, a full fourteen years earlier. Since the low of 1982, twenty-five years ago, the S&P 500 has risen 1370%. One dollar has become almost $15, equivalent to an 11.4% CAGR in 25 years, after a nominal CAGR of 0% for the preceding 14 years (significantly worse in real terms). Given the last 25 years and the preceding 14 years, the continuation of the bull market cannot be taken as a foregone conclusion, especially since the S&P 500 was already at its current level seven years ago.
In recent years, a new belief has taken hold among investors that 'there is always a bull market somewhere' and therefore, that it does not matter what the broader market does in general. This theory may be true and it has considerable appeal, in particular among individuals with a high degree of confidence in their stock-picking ability. However the sectors and stocks that continue to perform while the broader market is falling get narrower and fewer and only the very best long investors can expect to come out on top in a severe bear market. An easier and well-tested way to make money is to be an outstanding investor in a rising stock market.
It would be helpful therefore to identify the factors that have supported the bull market in the last 25 years and to try to see if these factors are likely to repeat themselves in the next 25 years. Some will and others will not. But there will also be new factors that will intervene and that will have a positive or negative impact. Here is an effort to sort it all out.
Factors that Helped the 1982-2000 Bull Market
Listed in random order:
- American Demographics: The baby boomers came of age with their high spending years starting in the early 1980s and continuing to this day. Their contribution to consumption and to American GDP cannot be overstated. It will continue for a few more decades but other sectors will benefit as the boomers retire and get older. Health care, travel and leisure are likely winners while broadline retailers and housing may suffer in many regions.
- Immigration: New immigrants have been beneficial in many ways. The Cold War accelerated the immigration to America of the best and the brightest from all over the world. Many of these immigrants who came to the US in the 1950s, 60 and 70s flourished in the 1980s and 1990s, creating large successful companies. Among them are Andy Grove, George Soros, and scores of others. The brain drain depleted many countries of their top talent. This situation has changed as democracy and free trade have spread around the world, and there is less incentive for future Groves and Soroses to leave their countries. The US may not attract the best minds in the future as it has in the past but our loss here can be mitigated by our participation in the global economy. To an extent, it matters not where an entrepreneur lives. American capital can probably find him, finance him, and benefit from his success. Another boost from immigration comes from the sheer increase of legal newcomers in the 1980s and 1990s, a process that has slowed in the current decade due to more stringent restrictions after 9/11. There is however a semi-underground economy with a continuing influx of illegal immigrants. Their presence is a hot political topic today but they benefit the economy by keeping wages down and contributing to consumer demand.
- Technology Boom: The introduction of the personal computer, then of the cell phone, then of the internet has created a new industry that has become a major component of the economy, an accelerator of globalization and an employer for tens of millions of people. The future holds much promise in this area and we can look forward to more technological advances.
- Free Trade Policies: These policies created and accelerated the free flow of goods and of capital, enabling most countries to capitalize on their comparative advantages. The industrialization and enrichment of other nations have created demand for American companies and have kept inflation in check. Barring a rise in protectionism, these trends will continue but they may benefit foreign markets more than the US stock market.
- Collapse of Commodity Prices and Interest Rates: In 1980, the Soviet Union had just invaded Afghanistan and it looked unstoppable. In the next 15 years, the 'evil empire' disintegrated, leading to a collapse in commodity prices. During the same time frame, inflation and interest rates in the US fell from double digit levels to low single digits. Lower commodity prices and lower interest rates were very helpful for the US economy. As we look to the future however, it looks like a world with higher commodity prices and higher inflation.
Of the five factors identified, two (technology boom, free trade) are likely to extend into the future, two (American demographics, immigration) are mixed, and one is decidedly negative (commodity prices and interest rates).
New Factors in 2007-2032?
Most investors in 1982 could not have foreseen the technology boom or the collapse of the Soviet Union. We must allow therefore for the unexpected and for its tonic or adverse effects. The unexpected is difficult to forecast by definition but here is an attempt to do so anyway:
- War and Terrorism: It is the ugly side of the coin of globalization and technology. Weapons are getting more deadly and more available. Relatively small groups can force the mobilization of large armies. See the American experience in Iraq and the Israeli experience in Lebanon. This trend will continue and may diminish the effectiveness of national armed forces. There may be other terrorist attacks in the US or in Europe, but if not massive, they are unlikely to impact the economy and the stock market for long.
- Geopolitics: The world has been a relatively benign place for Americans and for American capital in the last 25 years. In the future, newly assertive Russia and China are likely to mount new challenges to America and to American capitalism. In doing so, they may act directly or through proxies such as Iran, North Korea and others.
- Protectionism and Immigration: Free trade and a lax attitude towards illegal immigration have kept inflation low but they may have devalued our industrial base and weakened our national identity. There is a mounting reaction to both free trade and to illegal immigration. With this reaction comes an increased risk of inflationary pressures.
- Corruption: Despite the Enron and WorldCom of years past, corruption is not a systemic concern in the US and in Europe but it has been, and probably continues to be, more of a problem in emerging markets. When the economy turns down, there will probably be some scandals revealed in emerging markets which will dampen investor enthusiasm for these markets.
- Global Warming: Concerns about climate change will slow down the development of much- needed infrastructure and manufacturing facilities. This could slow down growth and create inflation. On the other hand, a whole new sector of green companies could rise from its infancy now to become an important part of the economy in the next 25 years.
- Diseases: The world has made great progress against epidemic disease in the last 50 years, but the occurrence of AIDS, SARS and avian flu is a reminder that a new great plague is not impossible.
The mix of new and old factors suggests a resurgence of inflation if growth continues at the pace of recent years. While not impossible, a protracted continuation of the bull market for the next 25 years seems improbable.