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S&P 500 – Historical Analysis

S&P 500 Log Scale Historical Prices with Linear Regression

As the stock market moves to the top of the current secular bear market trading range, it got me wondering how the current action in the index compares to its historical movements.

To get the data, I went to Dr. Robert Schiller’s website and copied the Monthly S&P 500 Index prices going back to January 1, 1871. Obviously, the index was not in place back that far and he has worked backwards from its inception date in the 1950’s to derive the prices prior to this date.

I plotted the data on a log scale chart, and added a linear regression line so we can see the trend, and calculated the compound annual growth rate.

As you can see from the chart above, over the past 142 years, there is a decisive upward trend that survived numerous recessions, wars, and a depression, and has provided a compound annual growth rate of price appreciation equal to 4.17%. When you add the average dividend yield of 4.44% over that same 142 years, you get a total return of 8.61%.

When I look at the chart, I see that we moved significantly away from the linear regression line starting with the 1982 tax reform that kicked off the 18 year secular bull market.

Since the peak on the chart in 2000, we have been moving up and down within a well defined trading range. You can see it on the chart above, but its easier to spot on the graph below that isolates this time period:

long-term-trading-range

What I am very concerned about at this time is whether there is some catalyst that will cause us to break out of this trading range and begin a new secular bull market – or whether we will continue to move up and down within the range over the next several years until the orange line on the top graph meets up with the linear regression line, providing a reversion to the mean.

This is a competition between two investment theories, one will be right and one will be wrong. One means higher stock prices the other means lower stock prices.

I’ve written here before about the difference between a cyclical bull market and a secular bull market. The cyclical bull is short term and is generally a positive upward move in prices within a larger/longer secular bear market. The big move higher in stock prices from the March 2009 lows that is so easy to see on the second graph above is a good example of a cyclical bull.

The secular bull market is a larger/longer push higher for stock prices that will contain some painful cyclical bear moves during its run. Many of you will either remember the 1987 stock crash because you lived it or you will have heard about it. It is a perfect example of a cyclical bear within a secular bull that lasted from 1982 to 2000.

A secular turn requires some major change in the investment landscape that fundamentally revalues stocks either lower or higher. In 1982 we had tax reform that revalued stocks higher for investors as corporate earnings grew and p/e ratios expanded, in 2000 investors finally realized that triple digit Technology P/E ratios were insane and valued the market lower.

Do we have some major catalyst today that will move both corporate earnings and P/E ratios higher – the golden goat of stock market investing? I am having trouble finding it – but welcome your emails if you see it as I’d love your input.

My best assessment is that the current secular bear market continues on and something will spook investors as we approach the mid-1500’s on the S&P 500 index (1565 is the all time high) sending it lower.

We have been selling into the rally, raising cash as I’ve mentioned here on the blog in previous posts – the March 1st sequestration deadline has the potential to take several percentage points off the index, and I want to have cash available to buy some of my favorite companies significantly lower than today’s prices.

However, just as I don’t see any catalyst to drive us into a new secular bull market (but would love to hear from anyone that does see one – unfortunately housing isn’t it, not enough impact) – I also don’t see anything that will drive us to the bottom of the trading range like 9/11 in 2001 and the 2007/2008 subprime/financial crisis.

I think we are in a trading range from 1125 to 1550, with most of the action in the 1300 to 1550 area. We would need something critically negative to drive us down 25% to 1125 – maybe the sequester will do it but that will likely only reduce GDP to the 1% or 1.5% range – probably not enough negative impact to fall that far.

I think it would take a true recession to push the market down 25%, and even though economic growth is very slow – unless the bond market starts to rebel against all of the debt we are piling on and we see yields move significantly higher in spite of the Fed keeping short-term interest rates at 0% – I can’t see that we are in for a recession.

One very important thing to keep in mind: you have to invest what you see and not what you believe. Stock prices can move up or down completely divorced from current economic fundamentals as investors commit or reduce money allocated to stocks based upon their perception of the future.

The stock market can act as a leading indicator and push higher because investors think the future will be better. Its quite possible that this is what we are seeing happening now.

I’ll leave you with a graph I watch that gives me more than just a feeling for major turns in stock price trends:

Stock Market Trend Indicator

I’ve circled some important times on the graph that were turning points for intermediate stock market trends. The way this works is that when the stock index crosses over its moving average at the same time the relative strength reading is at an extreme, we are in for a change in market direction.

I’ve been watching this for the past few months, and we have finally moved to an extreme in the relative strength, but we do not have anything close to a crossing of the index over its moving average.

This indicator tells me that no change in trend is imminent. We will likely pull back toward the trend line (low 1400’s) since the relative strength tells us we are getting ahead of ourselves, but that is only natural as stocks do not move straight up.

So, in summary I am cautious about the fundamentals and the potential impact of political decisions coming from our capital, but do not see any immediate move significantly lower on the horizon. We have cash on hand to reinvest when we get the inevitable move down to the trend line on the final graph above (low 1400’s on the S&P 500 index), but as long as we do not have a complete change in trend, the market can be higher at year-end than where it started 2013.

We will watch for a move above 1565 to determine if we have a new secular bull market underway and we will watch for a drop below the low 1400’s for a change in intermediate trend from cyclical bull to a resumption of the secular bear.


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Mark