SPX Cyclical Bull Lives
Source: Adam Hamilton, Zeal Research (7/16/10)
"Today's critical juncture will make or break your entire year."
It asserts the U.S. stock markets remain in a powerful cyclical bull (albeit within a secular bear). The 16% selloff in the flagship S&P 500 stock index (SPX) between late April and early July was simply a mid-bull correction. Such events from time to time are perfectly normal and healthy, as they rebalance sentiment to keep greed from getting out-of-hand before a bull fully runs its course.
The implications of this bull/bear debate are certainly not trivial. If the cyclical bull is dead, as the bears assert, traders need to sell positions, raise cash and maybe get short. But if the cyclical bull lives, traders need to buy positions, deploy cash and get long. These diametrically opposed outcomes will be greatly leveraged in sectors that amplify underlying SPX moves, including commodities stocks and tech stocks. Being right or wrong at today's critical juncture will make or break your entire year.
Before we pronounce the cyclical bull alive or dead, we first have to determine if the rally since March 2009 is indeed a cyclical bull. Many bears, well aware of what cyclical-bulldom portends, are arguing that all we've seen is a post-panic bounce. Never mind that this "bounce" blasted 80% higher and persisted for over 13 months by late April!
How can we differentiate between bull and bounce? One way is to compare the action since March 2009 with the most-recent cyclical bull before that. Between October 2002 and October 2007, the SPX relentlessly powered nearly 102% higher over a 60-month span. It is impossible to argue that this event wasn't a cyclical bull, and even the most belligerent perma-bears readily admit and accept this truth.
My first chart superimposes the recent 2009 and 2010 SPX action over the first couple of calendar years of that last cyclical bull, 2003 and 2004. That prior event was incontrovertibly a cyclical bull, so if the rally since March 2009 tracks it well, then we have nearly unassailable technical evidence that we are indeed experiencing another cyclical bull today.
Despite being separated by a big six-year gulf of time, the recent SPX action tracks the early years of the previous cyclical bull nearly perfectly. Their respective almost-interchangeable tracks are even carved near the same absolute levels in SPX terms, which is pretty remarkable. This provocative comparison slaughters the technical-bounce theory with extreme prejudice. There's no doubt we've been enjoying a textbook cyclical bull since March 2009.
Back in late April, only the most diehard bears disputed this notion. The cyclical-bull status of this past year's massive rally was generally accepted. But today, thanks to the sharp correction since, the bearish camp is increasingly undermining this assertion. Why? Because bears who are honest students of the markets know well that cyclical bulls never end after merely a year, even deep within the bowels of secular bears.
The big hang-up on today's cyclical bull is the severity and depth of the recent correction. In the early years of the last cyclical bull and the initial year of todays, there were no corrections. Corrections are generally classified as retreats greater than 10%. Anything less is merely a pullback. As you can see above, in both cyclical bulls the latter lesser selling episodes were the norm.
And after plunging 16% in 10 weeks ending earlier this month, the SPX is getting perilously close to bear-market territory in many bears' minds. The classic definition of a bear is a 20%+ decline off the previous interim high. When you are already down 16%, a couple sizeable down days are all it would take to exceed this classic bear-market benchmark. And as everyone knows, there is plenty of selloff-triggering bad economic news to go around these days.
With the fact that what we've witnessed since March 2009 inarguably has the classic technical signature of a young cyclical bull, a critical question emerges at today's all-important juncture. Can cyclical bulls recover from such large corrections midstream? Or are corrections approaching 20% so devastating psychologically that the bulls simply give up their ghosts right then? Do we have precedent of cyclical bulls within secular bears falling so sharply and then rebounding right back into their uptrends?
Before we dig into these questions, it is crucial to understand the difference between secular and cyclical. Secular trends last for very long periods of time, over a decade. Cyclical trends are much shorter, usually from two to four years. Cyclical trends oscillate within secular trends. A typical 17-year secular bear contains both cyclical bulls and cyclical bears, meandering sequentially through this secular timeframe.
Actually, the U.S. stock markets entered their latest secular bear in March 2000. Over the last decade, the SPX has been relentlessly grinding sideways to lower. I started warning investors about this coming period of stagnation way back in 2000 and 2001, years before this notion even started to enter Wall Street consciousness. I've written on today's secular bear and its implications countless times since.
Knowing whether we are in a secular bull or secular bear is definitely the single most-important strategic understanding investors can possess. It provides the grand overarching roadmap from which all investing decisions can be properly oriented for maximum profits. If you are not crystal-clear on secular bears, and why we are in one now, read my Long Valuation Waves 3 essay to get up to speed.
This next chart zooms out to compare our current secular bear with the previous one that ran from 1966 to 1982. While each secular bear was dominated by a seemingly endless span of agonizing sideways grinds, the markets meandered higher for years (cyclical bulls) and lower for years (cyclical bears) within these long trading ranges. These mid-secular-bear cyclical moves always alternate between bull and bear.
There is much to consider in this chart, but if you internalize it you will radically increase your odds of making the right decisions regarding when to expect cyclical bulls (go long) and cyclical bears (go short or weather the selloffs in bonds or cash). This precedent also strongly makes the case that today's cyclical bull in the U.S. stock markets is not rolling over into a cyclical bear again as the bears aggressively assert.
I marked every cyclical bull in each secular bear above so we have some reference point on how long these events tend to last. Prior to today's cyclical bull starting in March 2009, there was one other cyclical bull in our current secular bear as well as four in the last secular bear straddling the 1970s. Their lifespans are very telling, revealing that today's cyclical bull remains exceedingly young.
In the last secular bear, its four cyclical bulls lasted for 26 months, 32 months, 24 months and 33 months, respectively. This averages 29 months with a tight standard deviation since there were no significant outliers. The only other cyclical bull in our current secular bear lasted for 60 months ending in October 2007! But we can be conservative and use the shortest cyclical bull of modern times as our lifespan reference point.
Between October 1974 and September 1976, the SPX powered 73% higher over a 24-month span. Incidentally, this cyclical bull occurred at the very same point within the last secular bear as today's cyclical bull is at in today's secular bear. That earlier cyclical bull also erupted after a sharp cyclical bear that lopped 48% off the SPX by late 1974. Its whole technical profile is very similar to today's in many ways.
Our current cyclical bull was just over 13 months old by late April 2010 when the SPX started correcting. If the shortest mid-secular-bear cyclical bull witnessed in modern times lasted two years, the average of all five before today's approached three years, and the longest was five years, why on earth should today's suddenly die at barely one year old?
If we are indeed in a cyclical bull, and there is zero doubt based on these comparison charts, then we ought to expect a typical cyclical-bull lifespan. And despite what the bears are saying today, a single year is simply far too short. Precedent concedes today's bull could last as little as two years and as long as five years, but one year is just silly. The bull-bear cycles within secular bears are powerful and never short-circuited.
But what about the correction? Doesn't the SPX's recent sharp 16% plunge over 10 weeks overshadow cyclical-bull precedent? Doesn't it mean this time is different? Not at all! In that very same 1974–1976 cyclical bull that lasted two years in very similar conditions to today's, it witnessed a mid-bull 14% plunge over nine weeks. The subsequent cyclical bull from 1978 to 1980 (33 months) endured a 14% correction over 9 weeks and a brutal 17% one over just 6 weeks. Yet they continued powering higher on balance.
While large corrections within mid-secular-bear, cyclical bulls are far rarer than the typical sub-10% pullbacks, they do indeed emerge from time to time. And their bulls weather them and keep on plowing higher once sentiment is rebalanced. So arguing that because the recent correction was so big that our cyclical bull is in jeopardy just doesn't hold water based on historical precedent. Big corrections happen, yet cyclical bulls stoically soldier on.
There are also plenty of other arguments for today's cyclical bull remaining alive and well. Secular bears are not 17-year periods of falling prices as often assumed, but 17-year periods of sideways-grinding prices. The parade of cyclical bulls and cyclical bears creates a giant secular trading range. In today's secular bear, this works out to roughly 750 to 1500 on the SPX.
Not only does this flagship index remain low in its secular range today, but it just emerged out of its deepest lows of its entire secular bear in early 2009. Around 1100 now, the SPX remains closer to the lower end of this range than the upper end. So in secular terms, the SPX still has lots of technical headroom to power higher for the remainder of this cyclical bull. While I doubt this one will get anywhere close to 1500, it could easily achieve 1350 (100% total gain, just like the last cyclical bull).
The infamous stock panic in late 2008, the first true panic in 101 years, was driven by highly irrational fear-drenched selling. In its dark heart in October 2008, the SPX plummeted 30% in just four weeks! All but the most hardcore and extreme perma-bears would agree that such a precipitous plunge made no sense regardless of economic conditions. Well, that panic started from 1200 in September 2008. So as long as we languish below 1200, like we are today, the SPX remains in panic territory. This is not sustainable.
Another bearish argument used against today's cyclical bull persisting claims that the SPX has to fall below its March 2009 lows before this secular bear ends. I continue to be amazed at how many professional traders expect a sharp crash or a new panic that will drag the markets below those deep mid-secular-bear lows. But this argument also has no historical support.
Secular bears tend to see their worst lows near the middle of their 17-year spans, late 1974 in the last one and early 2009 in today's. For the rest of that 1970s secular bear, the stock markets never even came remotely close to revisiting those brutal late-1974 lows again. In today's terms, the lowest the SPX ever got after that mid-secular-bear point was roughly around 950.
Realize that secular bears are not about absolute price levels, but valuations. Secular bears are born because stocks are driven to valuations that are far too high to be sustained. The purpose of secular bears is to lock stocks in a long sideways range until earnings have time to catch up with stock prices. This means that the end of our current secular bear, probably in 2016, may very well occur near or above the top (1500) of the SPX's long trading range! We've almost certainly seen the worst lows already.
The 1970s secular bear started around 94 in the SPX, but was trading at a high P/E ratio of 24.1x earnings. By October 1974 (the equivalent of our March 2009 lows), it had fallen to 62 with an 8.7x P/E ratio. Yet when that 17-year secular bear ended in August 1982, the SPX was trading at 102 with the lowest P/E ratio yet of 6.6x. Anything under 7x is dirt-cheap, and such extremely low valuations are only seen at the ends of secular bears.
Realize that the end of the 1970s secular bear in SPX terms was actually 9% above its start! Yet valuations still collapsed by 73% over this 17-year span. So when perma-bears make arguments for new lows below March 2009's, realize they haven't really studied secular bears. These are valuation events, not price events. They are marked by sideways grinding, not a 17-year decline to their worst price levels right near their ends.
Amazingly it is possible, even probable, that the SPX will end today's secular bear around 2016 at a level slightly above the 1527 it started at in March 2000! And it is almost a certainty that this bear will end at SPX levels far above the March 2009 lows. New lower price lows are no longer necessary in this secular bear's second half. As corporate earnings gradually grow and catch up with stock prices, valuations gradually decline even as prices steadily climb out of their mid-secular-bear lows.
One more strategic observation: the first years of cyclical bulls, emerging out of deeply oversold cyclical-bear lows, are always the biggest. Following the bad years of 2008 (-39%), 2002 (-23%), and 1974 (-30%), the SPX rallied 24% in 2009, 26% in 2003, and 32% in 1975. While cyclical bulls' second calendar years aren't as good as the first, they are still pretty impressive. 2004 and 1976, the equivalent years to where we are in our cyclical bull today, saw gains of 9% and 19%. Since we started 2010 at 1115 on the SPX, a 10% to 20% rally would yield a year-end close of roughly 1225 to 1340. This is far higher than today's levels!
There are just no sound secular arguments for either today's cyclical bull dying in late April, or a new crash or panic driving a retest of the epic March 2009 lows. Probabilities overwhelmingly favor the U.S. stock markets continuing to rally on balance for at least another year as today's cyclical bull reasserts itself after its healthy correction. Interestingly, sentiment also supports this cyclical-bull-lives thesis.
This summer has been a rotten one sentiment-wise. Between the Marxists in Washington hellbent on radically raising taxes on U.S. investors, and the depressing oil spill in the Gulf, investors and speculators haven't had many reasons to be hopeful. But BP will almost certainly succeed in capping its blown-out well in the coming weeks, removing that albatross. And the months leading up to the critically important November elections will give American investors much hope that many Marxists will be thrown out of office. Today's poisoned sentiment environment will dramatically improve in the coming months.
One of the primary beneficiaries of this continuing SPX cyclical bull will be commodities stocks. They were hit hard in recent months as falling U.S. and China stock markets stoked demand fears. But as the SPX continues to power higher in this cyclical bull, commodities stocks will surge and dramatically outpace its gains. At Zeal we've been aggressively adding new high-potential commodities-stock trades recently. It isn't too late to deploy your own capital in these fantastic new trades at bargain prices.
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The bottom line is today's cyclical stock bull is very much alive and well. At barely a year old, it is far too young yet to give up its ghost. The recent big correction changes nothing, such events happen from time to time even within healthy ongoing cyclical bulls. And the SPX not only remains low within its secular trading range, but it is still trading in irrational panic territory. This is an anomaly that cannot persist.
So not only are the stock markets likely to continue rallying for the rest of 2010, but their gains should be strong. In order for this year to even come close to conforming to cyclical-bull-within-secular-bear precedent, the SPX needs to rally another 12% to 22% from today's levels. And leveraged sectors like commodities stocks will soar in such a scenario, greatly amplifying the broad-market gains.
Adam Hamilton, CPA
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