Stock market trading – Another day, another new record high

The US S&P 500 index closed on Friday at 1,900.53. It’s the first time the index has ever closed above 1,900 points.

What are the chances this tremendous run can continue? Pretty good actually, let’s take a closer look by examining the history.

If the stock market repeats one of the greatest bull runs in history, US stocks could more than triple over the next five years…even from this seemingly sky-high level…

One of the things we’ve had to put up with over the past few years are all those charts that compare the Great Depression and previous recessions with today’s market.

The idea is to prove that the world economy is still in a recession and that it will take another 20 years before the market recovers.

We get the idea that central banks have flooded the world economy with cash. We get it that this has created artificial stimulus. We get that it has created inflation. And we also get that one day there will be a ‘payback’ for this boom.

But until then what should you do? Sit and watch asset prices boom while you stay holding devalued cash? That doesn’t sound like a good idea to us.

Besides, how do you know when this boom will end? Because if we take a leaf out of the bears’ book, the rally since 2009 has all the hallmarks of one of the all-time great rallies — the 1990s bull market.

A boom in two charts

Let’s show you what we mean with two charts. The first shows the period from 1986 through to 2000. It shows the lead up to the 1987 stock market crash, the slow recovery, and then the boom from 1995 onwards:

US Stock market from Jan03 1986 to Sep 22, 2000 in upwards trend

Source: Google Finance

Note something important about this chart. Despite the stock market hitting new highs, it kept rising. That’s an important point, because a lot of the talk now among commentators is that because the US market has hit another new high, that must mean a crash is on the way.

Now look at the following chart. This is from 2007 through to the present day. It takes into account the 2008 meltdown and the subsequent rally:

US Stock market 2007 to 2014

Source: Google Finance

Can you see a potential similarity?

If you zoom in on the period in the first chart from 1987 to 1991 you’ll see that it took the market several years to recover. It was also a period of some volatility.

But after then the volatility began to drop, the market moved into a steady and gradual rise.

That’s understandable. Like the last crash, it would have taken investors some time to regain faith in the markets. And of course, over that period you get new entrants to the market, investors who have never invested during a crash.

Not knowing the impact of a stock market crash, these investors are more inclined to take a ‘devil may care’ attitude to stock investing. After all, for them they know one thing — stock prices only ever go up.

(It’s a similar attitude in the housing market that leads to buyers taking out bigger and bigger mortgages because all they know is rising house prices.)

US market to triple by 2020?

But even so, it takes time. And every step of the way during a bull market run you’ll get claims that the market is about to plummet to earth in a fiery ball of flames. That doesn’t mean the bull market won’t end. But it doesn’t mean it has to end now, just because the market has hit a new high.

Take this story from Forbes back in June 1992:

Over the past six months, the market has returned 12.3%. But now it may be time to move more cautiously. Wall Street’s market seers say that the bull could trip up in the months just ahead and possibly take a fall of 15%…

The bull market faces even more serious problems resulting from its rapid rise. One of the scariest is the puny dividend yield on shares, lately averaging 3% for companies in the S&P 500. That’s lower than it was in 1929. Stocks tend to run into trouble once the dividend yield drops much below 3%.

Back then the Federal Reserve Federal Funds Rate was 3%, roughly the same as the dividend yield on stocks. Today the Fed Funds Rates is 0.25%. And the dividend yield on US stocks? Well, that’s at an astronomical — compared to the Fed rate — 1.91%.

Like it or not, even if the US Federal Reserve stops growing its balance sheet this year, the central bank interest rate will still be a long way below the yield on stocks.

As we see it, today’s US market is at the ‘1992’ period. It wouldn’t surprise us if US stocks only eked out gradual gains over the next 18 months. That could be especially so as the market adjusts to the end of money printing.

But from then on, if history repeats (as we expect it to) the years leading up to the end of this decade could see stock prices repeat the 1990s boom. That would mean an index that triples, and the S&P 500 index reaching a record high above 6,000 points.

That may seem unthinkable today. But it probably seemed unthinkable to investors in 1992 that the index could reach 1,500 points from the then level of 480 points. And yet that’s exactly what it did a mere eight years later.

Stocks are booming and there’s still plenty more to come.

Story by Counting Pips.

Gary Beal