Content provided by Kostya Etus, CLS Investment Research Analyst
I recently read an article from Ned Davis Research Group on the global market outlook. Below is some information I thought our readers might find useful:
As the infamous Gordon Gekko once proclaimed, “Greed is good.” Although Gordon is a fictional character in the 1987 classic Wall Street, these words have likely been echoed by financial professionals around the world since the iconic film’s release 26 years ago. Gordon was right – to an extent. A developing secular bull market is characterized by long term growth, during which greed can be utilized as a valuable weapon for maximizing gains. However, an extended cyclical bull market is better classified as a short term market – even Gordon Gekko would know better than to let greed get the better of him in such a market. While this may be useful information what does this have to do with today’s market? The answer: history is always doomed to repeat itself.
1987 was a wild year for the markets – record highs had been the norm on Wall Street for the past several years which led to investors buying equity funds at levels never before seen in the market’s history. Dividend and earnings yields began to shrink in the face of extreme optimism. Eventually, with interest rates on the rise, sentiment reversed course. Disaster struck on October 19, 1987. Nicknamed “Black Monday,” the market lost a record 22.6 percent in a matter of hours resulting in the worst stock market crash in global history.
We recovered though; after the speculation was wrung out and valuations returned to reasonable levels, equities were able to recover alongside persistent economic growth. The S&P 500 was actually able to produce a 2 percent gain for the year and returned to record highs over the next 2 years with a 40 percent gain. This happened 5 years into the secular bull that started in 1982.
Does any of this sound familiar? In the first quarter of 2014 we will be entering the 5th year of the long-term uptrend started in 2009. From 1982 to 1987, the market had 25 percent annual gains. Over the last 5 years we have had about 23 percent. Further, the S&P 500 gained 25 percent over a similar time period, prior to a 1942 secular low as well as 1921.
That all said, Ned Davis Research believes it is unlikely to see a drop in the market as extreme as the one in 1987 when it dropped 34 percent, but they do believe the duration of the drop and subsequent short term reversal upward to be consistent. They compare it to the 2011 cyclical bear which was more “normal” with about a 20 percent drop. This has historically been a typical drop when the risks of a global recession were relatively low, as they are now.
Here at CLS we hope for the best but prepare for the worst. If a pullback in the market occurred, we would welcome the opportunity to purchase some cheap securities.