Second Quarter 2015 – Quarterly Commentary

Do Bull Markets die of old age…or, are they murdered?

“Bull markets are born on pessimism, grown on scepticism and die on euphoria”

Sir John Templeton

Who would we be to disagree with Sir John’s famous comment above? He is correct in every sense of the word but, while that may all be true, we as investment managers have to ascertain where we are at any point in the bull-bear market (and economic) cycle in order to enhance our clients’ portfolio returns or, to protect capital.


“If your neighbour loses his job, it’s a recession, if you lose your job, it’s a depression”


Thus, everything can be seen as relative. History provides great context in our efforts to put bull and bear cycles into perspective. Let’s start with this: Since 1785, according to Wikipedia, in the United States there have been no less than 49 “panics, recessions, and/or depressions” of varying length and severity. In that we are reviewing 230 years of history, we can reasonably conclude that ‘on average’ there has been a financial and/or economic setback every 4.7 years! But “averages” actually tell us very little other than that we are, “based on the averages”, not due for or, due for another downturn. Worse, averages can be out by a mile when compared with the length of any individual market or economic strength or weakness. Some of these downturns were rather short and mild – think here of the six month “Carter Recession” of 1980-81. Some can be catastrophic such as the “Great Depression” of 1929–33 or, the “Panic” of 1873 and the “long depression” of 1873–79. Of course, as with all things historic, if it happened a long time ago, to us it couldn’t have been as bad as what happened recently either because we weren’t there to participate or, we haven’t read our history. But, the truth is they were as bad or, worse, they have just faded from our living memory. For example, during the “Great Depression” of the 1930s, US GDP shrank 26.7% from peak to trough. In the “Long Depression” of 1873 however, business activity shrank by 33.6% and, not to be outdone, in the “Panic of 1893” it imploded by 37.3% and in the post WW1 “depression” it collapsed by a whopping 38.1%! By comparison, in the “Great Recession” of 2007-09, US GDP declined by a mere 4.3%. Economic volatility is a feature of life in the capitalist system.

And if you think the economy is volatile, check out the equity markets! In the “Great Crash” of 1929-32, the Dow Jones Industrial Index lost 90% of its value. In the 16 months from November 2007 t0 March 2009, the Dow lost over half its value (50.9%). For those who remember the “Crash of 1987” the Dow lost over 23% in one day!!!

Happily, there is another side to this coin. If we may define a “bull market” as that period of time through which the market doesn’t decline by more than 20% – admittedly, not a small number when one is experiencing such a decline – then there are lengthy and breathtaking periods of rising prices which have more than kept pace with inflation historically. Since the 1920s, there have been four “great” bull markets. That of the 1920s saw a rise of over 800%. The post-war bull market that commenced in 1948 and ran to 1966 saw a gain of 935%. The bull market of the 1980s saw equity prices rise some 850% and the bull run of the 1990s through 1999 (or, 2001 depending on your market index of choice) saw gains of 815%…truly breathtaking numbers! If only someone would “ring a bell” and tell us when to get out…

While we have thus far focussed on the equity markets, we haven’t forgotten about the fixed income markets. In fact, they are related. From 1966 through 1982, the Dow Jones index went from 1000 points to…wait for it…1000 points. Exactly nowhere on a capital basis. Actually, saying that it went nowhere is incorrect. Adjusted for inflation, the Dow declined by some 75% during that sixteen year period. Interest rates rose relentlessly during those years due to inflationary pressures brought on by the Vietnam War, massive new government programmes like the “War on Poverty”, the Boomers arriving in their early “accumulating” years, the two oil price shocks (’73-4 and ’79) and so on. By 1981, interest rates on long term US government securities had ballooned to over 15% (18% in Canada!) which effectively crushed everything in their path – certainly the bond and equity markets.

Then, in what seemed like an instant, everything changed. Interest rates began to fall, the bond and equity markets boomed, the US economy took off and by the end of the decade of the 1980s, the “Evil Empire” of the Soviet Union collapsed. With governments no longer having to spend so much on defence, the “Peace Dividend” showed up in balanced budgets (in North America), declining oil prices put cash back in consumer wallets and technology brought ever greater efficiencies to corporations and enhanced their bottom lines. As the song by the rock group “The Cars” went: “Let the good times roll”.

And for over 35 years, interest rates fell and fell and fell until they hit zero and for all intents and purposes, have stayed there since the dark days of 2009. That was the year we officially came out of the “Great Recession”. That was now some seven years ago and yet the economy is still only “growing” by some 2 – 3% per annum at best. What happens if interest rates do begin to rise? If it’s a reflection of a strong economy, then that would be good for equity prices because demand for products would be strong and so sales and profits would benefit. If it’s because of rampant inflation it would begin to resemble the 1970s and be bad news for equity and bond prices. Unfortunately, rising interest rates can only be bad for mid-to-long-term bond prices. If it were to be the result of a “panic” at home or, abroad, it could spiral out-of-control very quickly. And what could bring on a real panic or, crisis? Usually, it will be something unexpected which “shocks” the markets. The investment management business is about risk management and for good reason. Statistics show that clients receive half as much gratification or, euphoria when their portfolios rise as they experience fear and anxiety when their portfolios decline.

History tells us that all good things eventually come to an end. It just won’t tell us on a forward going basis, when. One could date this equity bull market from the bottom in March 2009. If so, it has already tripled from its lows and it took a great deal of “Quantitative Easing” by the Federal Reserve to get it there and interest rates at near zero. We can be quite confident that neither fixed income nor, equity markets can receive much, if any, more help from interest rates. This much we can say with total confidence: Relentlessly declining interest rates have been the “wind at our backs” over the last three plus decades and that almost by definition has come to an end. So now what?

If this were a game of “Clue” and one had to place their guess as to who will murder the bull market, with which weapon and where, we could say: “Mrs. White” (Janice Yellen) with the “Wrench” (interest rates) in the “Study” (Washington) or, we could say; “Mr. Green (Mario Draghi) with the “rope” (Euro policy) in the “Conservatory” (Berlin) or, we could say: “Colonel Mustard” (President Xi Jinping of China) with the “lead pipe” (permitting wild share speculation) in the “Hall” (Beijing). However, to date, this remains entirely speculative because we don’t have proof that the current bull market has expired – nor will we, until it declines by some 20%. Alternatively, going back to Sir John Templeton’s quote at the outset we might ask; with the market having tripled from its lows of 2009, how “euphoric” do you feel dear clients?