Being Bullish Because History Says So
by Charles B. Carlson, CFA
Dow Theory Forecasts
A lot of investors are bullish on the stock market these days simply because history says you should be. Indeed, if you look back through market history, what you'll find is that stocks rarely decline three years in a row. In fact, in order to find the last time large-company stocks posted three straight years of losses, you have to go all the way back to 1939-1941.
Yes, stocks declined in 2000 and 2001, and such a back-to-back decline hadn't happened since 1973-1974. Surely a third year of declines is not in the cards, is it?
The obvious problem with letting history determine whether you're bullish or bearish is that things change over time. The three engines that drive stock prices - corporate profits, interest rates, and inflation - do not run in consistent arcs.
For example, prior to 1982, the longest streak of annual gains for large-company stocks was six (1947-1952). For the most part, from 1926 through 1981, the market alternated two or three years of gains with a year or two or losses.
From 1982 through 1999, however, the pattern changed dramatically. In fact, from 1982 through 1999 - an 18-year period - large-company stocks declined in only one year (1990). And that wasn't much of a decline (a loss of just 3%).
The upshot is that if you had relied on history to determine whether to be a bull or a bear during this 18-year period, you probably would have gotten out of the market in 1985 or 1986 - after a nice four- or five-year run - only to miss the greatest surge in stock prices in history.
Are the factors that pushed stock prices lower in 2000 and 2001 still with us? Certainly the corporate profit picture should improve this year. But will profits improve to the point to justify the stretched valuations currently evident in the market? And what about interest rates? Judging from the Fed's latest action, the downward trend in rates looks, at least momentarily, to be over. And while inflation fears seem unfounded, one should not immediately discount what 11 rate cuts by the Federal Reserve Board could do to overheat the economy later this year.
Bottom line: Given how far the pendulum swung in the bullish direction from 1982 through 1999, investors shouldn't be surprised if it takes another year to work off the excesses of the '80s and '90s.
But one thing is for sure. If stocks do bounce back this year, rest assured it won't be because history says they should.
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