An S&P 500 Cyclical Bull?
Adam Hamilton October 3, 2003 3150 Words
Say it ain’t so! A new bull market in the mighty S&P 500?!? Have the rampaging bulls finally thrust the lethal sword deep into the cold black heart of the vicious Great Bear of recent years?
Believe it or not, but next week marks a major milestone in the US equity markets that is going to delight the bulls to no end and greatly discourage the handful of remaining bears. On October 9th, 2003, merely four trading days away as this essay is published, the S&P 500 will officially be in a bull market again!
That’s right fellow contrarians, an S&P 500 bull market is upon us!
The classical definition of a bull market is a 20%+ gain in a major asset class over a time period greater than one year. A sub-20% move in a single year falls under the official bull-market threshold since it is more of a grinding sideways trend. 20% is a nice round number and has just tended to stick throughout history as the benchmark of choice for defining a bull market. A relatively weak move, even with longevity, does not make a bull market.
On the other hand, a fast 20%+ move in less than one year has not yet proved its staying power so it doesn’t qualify as a bull market either. This time hurdle is a very wise distinction to make in defining a bull market since it filters out sharp yet short-lived bear-market rallies. The S&P 500, for example, has witnessed massive and violent 21% rallies in recent years, one in late 2001 and another in the summer of 2002, yet both of these major events failed to survive for an entire year. A relatively strong move, without longevity, does not make a bull market either.
But when the markets can somehow manage to cobble together both key ingredients, a 20%+ gain over a period of one year or longer, an official bull market is born. As of October 9th, the flagship S&P 500 will have managed to bag both the 20%+ and the year, earning itself a place of distinction in the rarified halls of official bull-marketdom.
Love it if you’re a bull, hate it if you’re a bear, or shrug your shoulders if you just don’t care, but the S&P 500 (SPX) index prices speak for themselves and the facts are clear. Another S&P 500 bull market is preparing to be born into the world with a due date of next week.
This whole fascinating twist of fate is readily apparent and crystal-clear in a short-term chart of the S&P 500. Our first graph this week zooms in to this epic move that has catapulted the elite SPX to the very verge of official bull-market territory once again. It’s been one heck of a rally any way you slice it!
Remember the brutal V-bounce of last October, the one marked above with the 777 Vegas-lucky closing low? Boy I sure do! Sentiment was abominable and folks were talking about an actual late-bust crash, the indices plunging off a cliff. Fear pervaded the market populace and the road ahead looked hopeless. If there was ever a bleak end-of-the-world sentiment running rampant, early last October was it!
Nevertheless a few belligerent contrarians, including I, decided to brazenly throw long and fight the despairing masses. I closed my October 4th, 2002 essay “Trading Volatility Ratios” with “…we are in for a spectacular bear market rally that will knock the socks off those not expecting it and yield legendary profits for those who are.” And so it was!
Rocketing off of 777 like a ballistic missile, the mighty S&P 500 screamed towards the heavens following its epic October 9th, 2002 V-bounce. It managed to rack up another very impressive 21% (what’s up with this recurring number?) bear-market rally by the end of November, and then started running out of steam and nosing over yet again.
The accelerating decay curve of early 2003 looked exactly like the early stages of another massive waterfall decline as the SPX bled red while eerily mimicking its initial decay pattern of recent-past waterfall declines. Yet, remarkably since sentiment was nowhere near negative enough to support a V-bounce yet, the US markets reversed directions faster than a pandering politician the very moment that Washington announced that it was going to go ahead and annex Iraq.
Yet before this latest mega-bear-market rally now widely known as the war rally launched, the S&P 500 did not plunge to fresh new-bear-to-date lows! As the graph above shows, the closing low on the flagship index was slightly under 801 on March 11th, 2003. Like it or not, the index carved a higher high and did not manage to formally retest its brutal October 2002 lows.
Market technicians, when looking at major support and resistance points, often deploy a 2% rule. In order to be considered a meaningful deviation from an earlier technical price point, any new technical price point must be 2%+ away from the previous one achieved. The March V-bounce in the SPX managed to close 3.1% above the earlier October V-bounce, so it was a meaningful new interim low from a pure technical analysis standpoint. The October uptrend remained intact!
Now many technicians, including I, would like to argue that the late 2002 bear-market rally and the war rally were two distinct and separate events, not one giant rally. The late 2002 bear-market rally was just a standard sentiment-driven V-bounce off of extreme fear, just like we have witnessed several times before in this Great Bear.
The war rally, on the other hand, was something entirely different. An invasion and annexation of one sovereign nation by another, something that has nothing to do with corporate profits or valuation fundamentals, managed to somehow unleash a vast torrent of pent-up greed. Unlike the late 2002 garden-variety sentiment-driven bear-market rally that was not at all uncommon, the war rally was a rare one-off non-repeatable geopolitical event.
These two rallies are very different in character and do not share a common root cause. Yet, from a technical purist perspective there is no doubt on the chart above that the October 2002 and March 2003 interim lows together form a meaningful uptrend. In the markets the closing prices are the ultimate reality, and the reality painted above is a contiguous one-year stretch of time, from October 9th, 2002 to October 9th, 2003, where the S&P 500 consistently carved a series of higher highs and higher lows.
This massive S&P 500 rally spawned as American bombs started falling on Iraqi cities on live television looked like it was topping last summer, but managed to burst higher in the past six weeks or so and majestically achieve a new closing high of 1040 in late September. From the October 2002 closing low to the September 2003 closing high, the SPX is up a magnificent 34%, a wonderful rally in the biggest index on Earth by anyone’s standards!
While the SPX has pulled back slightly from its late September highs, it is still up well over 20%. Provocatively if the index manages to stay above 932 (777 +20%) for the next four trading days until the October 9th close, it will officially be in bull-market territory.
Remember, all a bull market is is a 20%+ gain in a major asset over a period of one year or more. Next week the S&P 500 will almost certainly truly fulfill these criteria, no doubt causing the bulls to rejoice and the handful of bears left on the planet to wail and gnash our teeth. Welcome to the SPX bull market friends!
All due congratulations to the bulls aside, as they have put together a very impressive winning streak in the past six months or so, this achievement must be carefully considered from many perspectives. There are different types of bull markets, and amazingly enough a bull market and a Great Bear are not necessarily mutually exclusive, as Japan proved several times in the last decade.
Bull markets, just like bear markets, are classified into two distinct sub genera known as cyclical bulls and secular bulls. Naturally the distinctions between these two categories of major market trends are very important for investors and speculators to consider.
A cyclical market is a shorter-term long-term trend, a bull or bear market lasting for one or two years in duration before the trend ends. A secular market is a longer-term long-term trend, a bull or bear market lasting anywhere from around five years to well out over a decade. Naturally the longer a particular trend is in force, the more powerful that trend is considered to be. Therefore a secular trend, the longer kind, always takes precedence over a cyclical trend, the shorter kind.
On October 9th, 2003 the S&P 500 will officially enter a cyclical bull market. Unless this uptrend would manage to run for several years or more, it will remain a cyclical bull until proven otherwise. Now there is nothing wrong with cyclical bulls and they are always impressive, but can a short-term cyclical bull trump a much larger and more powerful long-term secular bear? That is literally the trillion-dollar question today!
Our first chart above showed a very impressive one-year SPX history, showcasing its cyclical bull market. Yet, if we place that cyclical chart into its proper strategic context of a massive secular bear market, the impressiveness factor fades considerably. To which trend do you attach more weight and relevance as an investor or speculator? To a 237-trading-day-old cyclical bull or an 873-trading-day-old secular Great Bear?
The dotted-red box highlights the area from which the first graph showing the cyclical bull above was rendered. Yes, an SPX cyclical bull is upon us, which is fine and dandy, but it is within the context of a far larger and more powerful secular Great Bear market. The one-year-or-so chart of the S&P 500 that looks so wonderful above doesn’t look like much more than a drawn-out bear-market rally from this crucial long-term strategic perspective.
Perspective truly is everything, in the markets as well as in life. If you are fortunate enough to possess the big picture about something you can easily figure out where you need to dig to find the details. But if you are mired in the tactical day-to-day trivia and oblivious to the big picture, you are in a world of hurt since you can’t even figure out where to look to perceive the grand strategic scene. The forest is lost for the trees! The new SPX cyclical bull, a great tactical achievement, must be considered within the crucial grand strategic context of the unfolding secular Great Bear.
There are a number of very important strategic facts that the bulls are not going to disclose as they trumpet the coming SPX cyclical bull far and wide in the coming weeks. Yet, prudent investors and speculators still need to be aware of these facts so they can decide for themselves whether to bet with the cyclical bull or secular bear moving forward. Only one trend will ultimately prevail!
All these strategic facts, not surprisingly, cast great doubt on the staying power of the S&P 500 cyclical bull. From all three of the key technical, fundamental, and historical perspectives, the big picture continues to appear to support the ongoing secular Great Bear downtrend, not the fledgling cyclical bull uptrend.
Technically, as the strategic chart above reveals, the SPX is mired in a heavy resistance zone above the famous S&P 500 neckline. When major trends shift, technical analysis suggests that major support zones during the Great Bull of the 1990s ought to become major resistance zones during the Great Bear of the 2000s. And this is exactly what we see above. The blue-shaded area shows the S&P 500 struggling in recent months in the same zone that used to support it during its secular bull days of last decade.
In addition to this ominous technical observation of major resistance now doggedly impeding the young cyclical bull, it is crucial not to overlook the brutal technical losses sustained in recent years. From its all-time high in March 2000 to its late September highs, a generous peak-to-peak measurement, the S&P 500 has plunged by 32%.
Losing a third of one’s scarce long-term capital in only a few years in the world’s ultimate supposedly blue-chip stock index is a horrific development. A cyclical bull that only manages to run up to an apex yielding a one-third total loss over a few years is quite suspect and perhaps not worthy of such widespread adoration.
From a foundational fundamental valuation perspective, the serious strategic doubts about the continued viability of this SPX cyclical bull multiply dramatically. If you examine the graph above closely, you will note three major V-bounces around the SPX 800 level in late 2002 and early 2003. These July 2002, October 2002, and March 2003 bounces occurred around S&P 500 P/E ratios of 25.7x, 25.8x, and 20.6x earnings respectively. Dividend yields for the mighty index weighed in at 1.74%, 1.82%, and 1.99%.
Now if this S&P 500 cyclical bull we are witnessing is really the start of something special, the end of the Great Bear and the beginning of a new Great Bull as the bulls so desperately hope, then the three V-bounces since the summer of 2002 simply have to mark the long-term bottom. This thesis presents an insurmountable problem though!
In the past century or so, the average valuation at major long-term bottoms occurred at a low general-stock P/E ratio around 7.6x earnings and a high general-stock dividend yield around 8.3%. Quite ominously, in market history P/E ratios and dividend yields similar to the ones the S&P 500 showed around its three recent V-bounces have always marked major long-term topping points, never long-term bottoms!
The US stock markets have never launched a secular bull market from valuations anywhere close to the average 24.0x P/E and 1.85% dividend yields recorded in the recent V-bounces. In order to believe that a long-term secular bull is really underway now, you have to completely throw out all of stock-market history and believe that we are in a brave New Era where valuations are now utterly meaningless. In other words, if this is true, the price you pay for a stock is irrelevant and no price is ever too high!
Sound familiar? This flawed argument should. It is the tired old early-2000 rationalization for mania extremes all over again. In 2000 the bulls assured us that valuation no longer mattered in our “New Era”, but they were proven dead wrong. Will the flawed 2000 rationalizations for overvalued markets suddenly and miraculously now begin working today? Does valuation matter or not? Does the price you pay for a stock matter? You have to decide for yourself.
I would not bet against history on the valuations and their necessary mean reversion! One year of cyclical-bull rallying certainly is not enough to overthrow centuries of market history.
And speaking of history, the strategic historical perspective is also very important to understand. Cyclical bull markets deep within the bowels of cyclical Great Bears are not at all uncommon. In Japan last decade for example, there were three separate cyclical bull markets within its Great Bear downtrend. One even pushed the flagship Nikkei 225 up by an amazing 59% in 18 months, vastly higher than today’s SPX cyclical bull in the States!
Yet, when all the dust settled, these cyclical bull markets ultimately failed and the overarching secular Great Bear easily crushed them and battered the Japanese markets down to abysmal new bear-to-date lows. There is no historical precedent to suggest that the advent of a cyclical bull alone is enough to end a Great Bear. Indeed, the Great Bears seem to relish the opportunity to allow cyclical bulls to temporarily run in order to suck in more naïve bullish capital to destroy.
And this brings us to the bottom line! The entire job of the Great Bear is to mercilessly destroy the speculative excesses that led to the preceding bubble. The Great Bear is exceedingly clever and deceptive in this macabre task. It steps back and allows rallies, sometimes enormous ones, to lull folks into a false sense of complacency.
The Great Bear deftly maximizes its ultimate damage by not revaluing markets all at once and scaring people out, but by revaluing them slowly over many years so folks don’t realize that they are being slowly flayed alive. It’s like the old frog proverb, where a frog is boiled in a pot where the water temperature is slowly raised over time so the frog doesn’t realize its mortal peril until too late.
In terms of grand Great Bear strategic deceptions designed to suck in more capital to annihilate, there is nothing more effective than exciting cyclical-bull markets, 20%+ gains over one year or more, deep in the bowels of the secular bear. People who don’t understand history and valuations are easily deceived and the cyclical bulls seduce and trap them into deploying capital well before the ultimate Great Bear bottom at historically undervalued levels is achieved.
How do you invest and speculate in such a dangerous environment as this, where history suggests the Great Bear has a long way to go yet while Wall Street trumpets that the Great Bear is dead? In the new October Zeal Intelligence newsletter just published a couple days ago for our subscribers, I described exactly how we are playing it at Zeal.
We are patiently watching and waiting for very specific signs that should allow us to ride out the SPX cyclical bull with our speculative capital intact but at the same time jump back in and short with a vengeance when the Great Bear chooses to reappear. I explained the technical signals that we are zealously watching for in order to deploy fresh new QQQ options to ride the indices when appropriate.
I also discussed the potential impact on index speculation of the Fed’s massive currency debasement (or “liquidity injection” as the popular Wall Street euphemism optimistically calls it) and the 2004 election cycle in this new issue of ZI.
Please honor us with your subscription today to see how we apply the research in these weekly essays in real-world investment and speculation! All new e-mail PDF-edition subscribers will be promptly e-mailed a complimentary copy of the new October ZI as our heartfelt thank you for trying out our contrarian newsletter. My team and I would love to serve you!
While a cyclical S&P 500 bull market is upon us, it doesn’t change or negate the long-term secular Great Bear trend already in place. As always, the contrarians will ultimately win the day. Valuations and history still matter and those who scoff at these core financial foundations will see their capital utterly annihilated when the Great Bear reasserts itself sooner or later with a vengeance.
Adam Hamilton, CPA October 3, 2003 Subscribe at www.zealllc.com/subscribe.htm