Markets & Finance

The Bull Market Turns Five


We review the patterns of prior bull markets to gauge the chances that the S&P's current run will reach its sixth birthday

From Standard & Poor's Equity ResearchCue the cake and candles: Oct. 10 marks the fifth birthday for this cyclical bull market. Back on Oct. 9, 2002, the Standard & Poor's 500-stock index posted a closing low of 776.76, which eventually marked the end of the bear market that began on Mar. 24, 2000, and erased 49% of the index's value. The S&P 500 received official cyclical bull market status on Nov, 21, 2002, when it closed at 933.76, more than 20% above the Oct. 9 close. (S&P defines a bull market as an advance of at least 20% from the low set during the prior bear market.)

Based on the Oct. 8, 2007, close of 1552.58, the S&P 500 is 103% higher than it was on Oct. 9, 2002. Yet this milestone, while certainly making many people happy, offers up a few questions: How does this bull market stack up with prior bull markets, and how much longer does this bull have to run?

Average Annual Bull Market Returns

Take a look at the accompanying table, which shows the bull markets in the S&P 500 since 1942, and lists the starting and ending dates, duration in months, annual (365-day, not calendar year) price changes, and cumulative amounts recovered of the prior bear market declines.

By S&P's definition, there have been 10 completed bull markets for the S&P 500 since 1942, averaging 56 months in length. Having just recorded our 60th month of this current bull market, it may be surprising to some to realize that 3 of the prior 10 bull markets have lasted longer, with the bull market of 1990-2000 being the longest at more than twice the average duration, and the 1966-68 bull market lasting less than half the average number of months.

Investors who constantly worry about investing just at the top of bull markets should be encouraged to know that investors usually don't have to wait until the cows come home before the new bull market has recouped the losses experienced in the prior bear market. After one year of a new bull market, an average 86% of the prior bear market's decline has been recovered. On average, all of the prior bear market's decline, and then some, was recovered by the second year of the new bull market—except for the bull markets of 1942, 1974, and 2002, which followed bear market declines in excess of 45%. Based on this bull market's 103% recovery of the prior bear market's 750-point decline, this bull market's performance places it among the slowest recoveries since 1942, besting only the 82% fifth-year recovery for the bull market of 1974-80.

Average Annual Advances

Even though past performance is no guarantee of future results, it doesn't hurt to have an understanding of prior bull markets. During the first 12 months of every bull market since 1942, the S&P 500 posted an average increase of 38.0%. What's more, none of the industries in the S&P 500 posted an average decline during first-year bulls from 1968-2003, probably contributing to the genesis of the old Wall Street adage that "A rising tide lifts all boats." Second-year bull markets —which I call "the tolerable twos"—have also been pretty good to investors, in our opinion, since the S&P 500 rose an average 11.4% and recorded no declines, despite first-year increases from 21% to 58%.

Third-year bull markets have been the most challenging for investors, in our view, and have frequently signaled the end of easy money. In the past 60 years, the average price advance was only 3.9% during the third year of a bull market. More important, however, was that six of the third-year performances were disappointments to investors: one year the S&P 500 rose only 2.0%, while declining five times. And of those five declines, three became official bear markets shortly thereafter.

Fourth-year bull markets remind me of the demographic factoid stating that folks who make it to age 65 have a great chance of making it to 85: A similar pattern holds for the eight bull markets that started their fourth year. Seven went on to celebrate a fifth birthday, with the only decline coming in at less than 3%. What's more, the S&P 500 typically caught a second wind during the fourth year, as evinced by its 13.2% average performance—the third-strongest of all six. The fifth year has frequently been a fake-out. Historically, the S&P 500 has either quickly rolled over and died—as in 1946 and 1961—or marched on to a healthy return of almost 9%. During the 12-month period that is just about to end, the S&P 500 is on track to post an advance of nearly 15%, more than 6 percentage points above the average gain in fifth-year bull markets.

The $64,000 question is whether the S&P 500 will celebrate its sixth year and post a double-digit gain like three of the four bull markets since 1942, or crash and burn soon into its sixth year, as in 1980. S&P's equity analysts, using their 12-month target prices for S&P 500 companies, project this U.S. large-cap benchmark to advance nearly 12%, ending September, 2008, near the 1700 level.

Factors acting as catalysts to their optimism include a 13% forecasted increase in operating earnings for the S&P 500 in 2008, following a 6.6% projected rise for 2007; at least two more Fed rate reductions of 25 basis points each by the January, 2008, FOMC meeting; and a 9% decline in the value of the dollar against a trade-weighted basket of foreign currencies.

Fascinating Forecasting

If fundamental projections, based on discounted-cash-flow analysis, relative peer valuations, and sum-of-the-parts techniques aren't convincing enough, consider these additional reasons to believe the S&P 500 will likely celebrate its sixth birthday next October and post a respectable gain in price.

Next year is a Presidential election year, typically the second-strongest year in the four-year Presidential cycle. Since 1945, the S&P 500 gained an average 8.6% in an election year (without dividends reinvested) and posted an advance 80% of the time. I think this strength could be a carryover from the stellar average performance of the third year of a President's term in office, in which investors attempt to anticipate the benefit to the economy that a stimulus package initiated by the party in power (that wishes to stay in power) works its way through the economy and into voter's wallets. Of course there is no guarantee this will happen in 2008, but the track record is still encouraging.

And speaking of the figure "8," since 1945, years ending in 8 have gained an average 14.2% and risen 83% of the time. I have absolutely no explanation as to why this is the case, but since I did the work, I wanted to share the results.

So there you have it. S&P equity analysts are projecting a favorable 12-month period. And if history serves as a guide, we just may get it.


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