Bull Market Feeling Its Age?


Small investors are day-trading again, helping drive business at some discount brokerages near record levels. Meanwhile, the number of initial public offerings reached a more than 10-year high for the first two months of 2014; margin debt is at an all-time high; and shares of unprofitable companies are leading the market's advance.

These trends will not bring much comfort to investors who recall the run-up to the bursting of the technology bubble in 2000.

Yet other indicators suggest that sentiment is not especially exuberant. About 40% of individual investors are bullish, says the American Association of Individual Investors, up sharply from early February but roughly in line with the long-term average of 39%. Almost 55% of investment newsletters are bullish, reports Investors Intelligence, above the long-term norm of 46% but below the six-year high near 62% in December.

Bears argue U.S. stocks' five-year-old advance, now slightly older than the typical bull market since 1921, is not long for this world. "Over the course of the year, inflated U.S. stock prices will be battered by both disappointing earnings and lower P/E ratios," according to Christopher Kendzierski's FSG Market Commentary. "We expect 18 months from now the U.S. stock market will have given back all of the 2013 bubble gains and much more."

While nobody really knows how long this bull market will last, the business cycle can provide perspective. Business cycles tend to last nine to 11 years and can be broken down into five phases, according to the CFA Institute, as described below.


1. Initial recovery — Governments install stimulus policies, Treasury yields decline, and stocks surge as recession concerns ease. Riskier investments tend to outperform.

2. Early upswing — Economic confidence improves, unemployment starts to fall, inventories build, profit margins improve, and short-term interest rates rise as the government begins to unwind stimulus. Inflation remains low. Stocks continue their upward trajectory.

3. Late upswing — Confidence is high, unemployment low. Inflation rises as the economy risks overheating. Stocks usually extend gains, but may be volatile.

4. Slowdown — Economic growth decelerates, confidence wavers, interest rates rise, inventories are slashed, and short-term interest rates peak. Stocks usually decline.

5. Recession — Gross domestic product declines for at least two consecutive quarters.

So, where are we now? Recall that the last recession stretched for 18 months, officially ending in June 2009. Based on the CFA Institute's business-cycle guidelines, we may be moving toward the end of the early upswing phase.

Inflation was 1.6% in the 12 months ended January, roughly flat from a year ago and below the Federal Reserve's target of 2.0%. Unemployment fell to 6.6% in January, down from the high of 10.0% set in October 2009 but still well above the 4.4% to 5.0% seen before the recession in 2005. In a December survey, most Fed officials said they expected rates to start rising again in 2015.

The Fed used newly created money to buy $65 billion of Treasury and mortgage bonds in February, down from $75 billion in January and $85 billion in preceding months. The Fed plans to continue tapering in "measured steps" and could completely wind down the bond-buying program this year.

Fed Chair Janet Yellen said in late February that unseasonably cold weather dragged on economic growth early this year. The degree of weather's role in the weakness is uncertain, but stocks have taken the taper in stride, as the U.S. economy pushes forward with less help from the Fed.

Of course, real life does not always conform to the tidy explanations in textbooks. Four years is unusually long for the economy to remain in the early upswing phase, and no textbook can predict the impact of geopolitical crises like Russia's move into Ukraine. Still, based on the weight of the evidence, the U.S. economy and stock market may have room to run.

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