WASHINGTON, Jan. 1 (UPI) -- It's been another decent year for Bear fans, with a solid victory, albeit modest, compared to what looked likely at the end of the third quarter.
By the Dow Jones index, the Bears won by a 7.10 percent index drop; by the S&P 500 Index, they did rather better, with a drop of 13.05 percent. In the end, 2001 was a pretty similar year to 2000, when the Dow Jones index dropped 6.18 percent and the S&P Index dropped 10.14 percent. A win for the Bears, but not a blowout.
Last year at this time, I wondered whether 2001 would provide a Super Bowl for the Bears, a year in which the major stock market indexes dropped by 25 percent. It didn't happen, of course, but at that time I also raised what I described as the "true danger," a long series of Bear wins, in which the market drops each year, investor participation dwindles to the level of utter apathy, and economic renewal slows to sluggish levels.
A Bear "trifecta" in 2002, with the index down in three successive years, is certainly possible, but at first sight not very likely. On either the Dow or the S&P 500 Index, it hasn't happened since 1939-40-41 (years in which the economy was beginning to recover quite nicely, incidentally) and before that only once, since 1896, with the infamous 1929-30-31-32 sequence. In other words, trifectas are rarer than Super Bowls, of which there have been seven in the last century.
However, there's no question that the downward market momentum is still there. To demonstrate this, we should take the S&P 500 year-end closes by 1928 and deflate them by the December Consumer Price Index for the same year.
This makes the 1929-32 crash somewhat less horrendous, since prices were deflating during the period, and the 1968-81 stagnation, actually a very prolonged bear market, look much worse. However, by correcting for the deflation of the 1930s and the high inflation of the 1970s, it gives one a much better picture of stock market behavior over a very long period.
Over this entire period, with the deflation, the best five-year period was 1994-1999, up 23.3 percent per annum, the best 10-year period was 1988-98, up 12.52 percent per annum, the best 25-year period was 1974-99, up 7.84 percent per annum, and the best 50-year period was 1949-99, up 5.15 percent per annum. On an inflation-linked basis, the 1981-99 bull market (with intermediate peak in 1989) propelled the indexes up faster and further than any previous period since 1928.
Stock market returns, over the long term, were far, far lower than investors have got used to over the last decade --- it is shocking to note that over the 50-year period 1928-1978, the market had in real terms a slight negative return. Yes, stocks will do well over the very long run, but will even the youngest of us live long enough to enjoy it?
Let's look at the flip side of this. If the 18 years to 1999 produced record high stock market returns, then the period following 1999 might produce record low returns. Over a five-year period, the record low return was minus 14.47 percent, in 1936-41 (no, NOT the Wall Street crash). On that basis, assuming 2 percent per annum inflation, the S&P 500 will be at 743 in 2004, down more than 35 percent from today. Over 10 years, the lowest return was minus 6.98 percent per annum, over 1968-78 (now THERE's a little-known bear market period), on which basis, the S&P, given 2 percent per annum inflation, would be at 869 in 2009, still more than 25 percent below today's level, eight full years from now.
Over 25 years, the lowest return was minus 1.71 percent, over 1928-53; that would give a 2024 S&P 500 nominally higher than today at 1,565, but what a miserable 23 years we have ahead of us in that case! A 42-year-old today hoping to retire at 65 had better hope his fund manager's stock-picking skills are good, or he may find himself out of pocket, even before taking account of a 64 percent increase in prices.
Another way of looking at this is to fit the inflation-indexed S&P 500 indexes into a regression, and attempt to predict where, based on historical trends, the inflation-indexed S&P should be in December 2002. This is a very disturbing exercise indeed. Based on the trend line since 1928, adjusted for inflation, the deflated S&P 500 Index at the end of 2002 should be at 135.6. Taking a deflator of 550 at the end of 2002, which assumes about 2.5 percent inflation over the December 2000-December 2002 period, this suggests that, merely to be at an average valuation level, the S&P 500 should be at 745.88 on Dec. 31, 2002.
Bear in mind, too, that this is a projected average level for the index, not a likely bottom!
If that average holds, then 2002 will indeed be a Super Bowl for the Bears, with the market down (35) percent during the year.
In practice, with the Fed having dropped short-term interest rates 11 times in 2001 and with a tax cut and parts of a stimulus package both having been enacted, the government is fighting extremely hard against the declining market -- we project a $200 billion federal budget deficit in the current fiscal year, which ends Sept. 30, 2002. Thus it is likely that instead of this Bear Super Bowl, which would concentrate the stock market decline into one really terrible year, a long series of moderate Bear wins will take place. After all, the 1990s were a decade in which the Bulls won nine years out of 10, it's only reasonable that the Bears should have their turn in the 2000s. There has never been a decade, not even the 1930s, in which the Bears have done better than split 5-5 with the Bulls; the 2000s may be the first such.
As for a trifecta, it's likely, but not certain. It's possible that all the short-term stimulus injected into the economy will cause a modest revival in the middle of 2002, and that the stock market will be sufficiently encouraged to finish 2002 above 2001. However, given the market's strength in the fourth quarter of 2001, I very much doubt it. Even if the economy does recover for a few months, with the investment overhang of the late '90s remaining, it will be nothing but a double dip, with the second dip taking both the economy and the market to levels lower than the first.
Very much like Japan since 1990, in other words. A Bear Super Bowl, which took the Dow Jones index to 4,500 and the S&P 500 Index to 550, both safely below their equilibrium levels, would be greatly preferable, because it would mean we could start a proper economic recovery, with concomitant creation of jobs and economic opportunity. A lengthy succession of poor but not catastrophic years, on the other hand, would be much more damaging to the economy's long-run growth, because of its depressing psychological effect. We all have only one working life, after all, and who wants to spend more than a quarter of it mired in a downturn with no interesting opportunities?
2001 was a tough game for the Bears; the second and fourth quarters have been played mostly on defense. But in the end they came through, and pulled out another win. Now they look still stronger, still more confident than 12 months ago, facing a Bulls line that is looking despondent. Whether they win a trifecta or not, the Bears know that there are winning years ahead.
(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the last 10 years, the proportion of "sell" recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
