Is This Time Different?

There are two questions perplexing all investors today: Is the bull market in US equities in a bubble, up some 48% since the crisis of 2009? And is the 30-year bond market, where yields on US Treasuries have fallen from 16% in 1981 to 1.14% in 2012 (prompting inversely a rise in stocks) also in a bubble, and about to collapse?

Or is this time any different?

To quote the investment sage Sir John Templeton, “This time is different are the four most expensive words in investment history.”

There is broad consensus that valuations of US stocks are historically high. The S&P 500 Index of the top 500 US companies by capitalisation has posted three all-time highs this year – something never seen before in history. The longest running bull market ever (surging market prices) ran 10 years, and this bull market is already in its 10th year.

Bull markets do not die of old age and when they do, it’s hardly ever with a whimper. They die when hit by a “shock” event, and they are particularly vulnerable in times of euphoria. As innovations grow in technology on which markets and the financial system are dependent, the risk of a severe loss of connectivity to the “cloud” or cyberspace is a trigger for a “shock” event.

Regulator bias is another likely trigger. Regulators tend to focus on the same areas of risk and are reactive. They will miss the next “shock” event. Unfunded entitlement benefits act as a strong headwind to growth in the US and many developed economies. US tax cuts add trillions to US companies, but it is unfunded.

Historically we had three equity bull market bubbles that burst: two in the US and one in Japan. The two in the US, in 1929 and 1999, had a common dramatic factor: in the 6 months prior to collapse, the market gained in a sharp “melt up”, about 21% in 1999 and 100% in 1929. This final “gasp” heralded euphoria. We have witnessed euphoria recently with Bitcoin.

Euphoria in the stock market needs to be “oiled” with good fundamentals for a sharp acceleration of prices. As I write, the S&P has corrected downwards by around 3% but if the 2017 upward trend continues, in some 21 months the S&P will have increased by 60%, as in the final stage of the 1999 bubble.

Many money managers today are too young to have invested through the events of 1999. Experience of adverse market conditions makes staying the course easier and the investor or advisor less likely to confuse a “bull market” with “brains”. Sensible long term investors have a well-diversified global portfolio of low-cost index funds and will stay the course.

Is this time different? Probably not.

Jeremy Blatch TEP
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This article was also published in the online and print editions of the Sur in English