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Was 2009 the best bull market ever?

John Rekenthaler  |  22 Jun 2018Text size  Decrease  Increase  |  
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Dow Jones Hits 26,000

This may not be the best stock bull market in modern US investment history; the 1950s and 1990s are formidable rivals. By any standards, though, tripling one's money in real terms, in less than a decade, rates as a great success. That this gain occurred during a period of low volatility, with few large reversals and subdued inflation, heightens the achievement.

Yet almost nobody called it. Somebody, somewhere, advised near the market's bottom that investors load up on stocks. Not many, though. The best example that I can recall was GMO's Jeremy Grantham, who said in January 2009 that while stocks were not "dramatically cheap," they were worth buying, as he expected them to generate a 65 per cent real return over the next seven years. Half correct; stocks rose 130 per cent for that period.

In hindsight, 2009's economists had the right starting point. They believed that a single, overwhelming economic trend would drive the next decade's stock market results. Unfortunately, they were unable to identify that trend, emphasising instead two predictions that did not materialise.

GDP growth into corporate profits

The consensus economic belief emerging from 2009's rubble was the arrival of the "New Normal". For decades, the United States had hamstrung its economy through deficit spending, aided and abetted by consumer borrowing. That bill had come due. To pay it, the nation would be forced to tighten its belts by cutting spending and strengthening its balance sheet. Those actions would depress GDP growth for years to come, thereby impairing stock prices.

That forecast was broadly accurate. Not once during the recovery did annual real GDP growth, as measured from one calendar year to the next, reach 3 per cent. Such a figure was once commonplace. For example, during the seven-year stretch from 1983 to 1989 and the five-year period of 1996 to 2000, GDP growth always exceeded that mark.

What the forecasters overlooked was that GDP growth doesn't much matter. They all knew that to be so. Seven years before, the book Triumph of the Optimists, written by three London Business School professors, had shown, to much acclaim, that there is little correlation between a country's overall economic growth and the performance of its stock market.

The reason that GDP growth tends to be immaterial is that, although it signals increased activity, there's no telling who gains from that activity. It might be oligarchs, who scoop the nation's output into their offshore bank accounts. It might be labour, which devours all those benefits in the form of wage increases. It might be empire-building CEOs, who plough their companies' cash into unprofitable new ventures. There are many ways to spend GDP growth besides increasing corporate profits.

In the case of the US, however, every penny of GDP growth went into boosting corporate profits. And more. Benefiting from a historic advantage over labour, which kept their costs low, and refraining from making large capital investments, which kept their margins high, US companies have made money like never before.

Ultimately, stock prices are determined by two factors: corporate profits and inflation. The New Normal greatly underestimated the benefit of the first of those items.

QE fears overblown

At the same time, fears about quantitative easing overestimated the hazard of the second. Exiting the 2008 financial crisis, global governments wished to stimulate their economies but had difficulty doing so because their short-term interest rates were near zero. They turned then to an unconventional approach: so-called quantitative easing, whereby their central banks would purchase government bonds in the open market. This would have the twin advantages of supporting bond prices and increasing the money supply.

To critics, of which there were many, the cure was worse than the disease. Flooding the money supply to an even greater extent than was already being done through short-term rates would inevitably bring inflation – if not sooner, then surely later.

That, obviously, has not occurred. Bond prices, far from being in a temporary "bubble", remain firm; the dollar is stronger against the euro, British pound, and yen than it was when that passage was written; banks have suffered no fresh crisis; consumer confidence has been fine; and business activity has steadily risen. None of the quantitative easing warnings have come true.

Much of the argument against QE was politically motivated, which meant that portion of dissent was useless. The informed critics cannot be fully absolved, however. Once again, they had not upgraded their software. By the end of last decade, it had become clear that the traditional link between money supply and inflation had become tenuous. Those who warned against quantitative easing should have beaten their drums less loudly.

Why the numbers mtter

1) Economics matters, greatly. The combination of persistently high corporate profits and quiescent inflation fully explains today's Great Bull Market. The market's gains owe to numbers, not to sentiment.

2) Getting the economics right is a very difficult task. Doing so requires being correct about many things.

3) Too often, economic forecasts become groupthink. Following the 2008 financial crisis, too much attention was paid to the New Normal and quantitative easing critiques, while too little attention was paid to alternative views.

  

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John Rekenthaler is vice president of research for Morningstar, based in the US. He is a columnist for Morningstar.com and a member of Morningstar's investment research department. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is vice president of research for Morningstar.

© 2019 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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