By Anatole Kaletsky
May 9 Two months ago, when Wall Street first
approached a record high, I warned about the dangers of "stock
market vertigo" - a condition that combines the fear of buying
shares at unsustainably high prices with the equal dread of not
buying shares at prices that will never again be on offer if the
market soars to permanently higher levels.
At that time the world's most closely followed index, the
Standard and Poor's 500, was still bouncing along the top of a
trading range that had held since the bursting of the Internet
bubble in March 2000. There was no way to know whether the
market's next big move would be a plunge back toward the middle
of this 13-year range or a rise to new and significantly higher
On one hand, improvements in the U.S. economic outlook and
political situation at the end of last year suggested that a
breakout was more likely than the last time the index came close
to its 2000 peak - in late 2007, when the subprime mortgage
crisis was just starting and George W. Bush was still president.
On the other hand, the European crisis looked as bad as
ever, China seemed to be slowing, corporate profits were
stalling and investors were well aware of the huge losses
suffered by people who got sucked into the market when it hit
similar levels in 2000 and 2007.
There was no sure way to resolve this dilemma two months
ago, and there still isn't, since prices in financial markets
are always balanced, by definition, between bullish and bearish
expectations that are roughly equal in plausibility.
But the market's behavior sometimes suggests an answer - and
this week appears to present such a case. In the week since last
Friday, when the United States reported much stronger than
expected employment growth, the S&P 500 has moved more than 4.0
percent above the 13-year trading range defined by the 2000 and
2007 highs. This breakout has been confirmed by the Dow Jones
industrial average and by broader Wall Street indexes, such as
the Wilshire 5000 and the S&P equal-weighted index. And while
share prices in most other countries are still far below their
2000 and 2007 levels, the Tokyo stock market has taken off like
a rocket and Germany's DAX has matched Wall Street's ascent.
This bullish behavior does not mean that prices will keep
rising - by definition, the next daily move in any actively
traded market is as likely to be down as up. But the records
that have been set do mean that the plausible upside to stock
prices is no longer limited to just a few percent, as it was
when Wall Street seemed to be trapped in a range that had held
for 13 years. Now that this range has been broken, historical
patterns suggest further big gains in the years ahead, while a
relapse into the old range seems unlikely. I described this in
detail two months ago, so here is just a brief reprise.
In the past 100 years there have been eight occasions when
stock prices on Wall Street, as gauged by the S&P 500 and its
predecessor benchmarks, have broken long-standing records by 3.0
percent or more. All these records have been followed by further
big price gains - doubling or tripling in the subsequent years,
except for one occasion, when the S&P rose only 15 percent. None
of these breakouts have been followed by a significant price
decline for at least six months.
Of course, past experience is not necessarily a guide to
future performance. Indeed, academic economists generally
dismiss the "chartists" who study market history as irrational
latter-day astrologers, exploiting the superstitions of naïve
investors. But apart from the fact that chart-based technical
trading accounts for the bulk of activity by the very investors
assumed to be perfectly rational by the academic economists,
there are several fundamental reasons to believe that this
week's stock market activity could mark the beginning of a
long-term bull market and the end of the range-bound trading
that has lasted for 13 years.
The first reason is the passage of time itself. When shares
become overvalued, as they did in the boom of the late 1990s,
they generally experience a price correction and a time
correction. Stocks such as Microsoft, Intel and Amazon, which
seemed ridiculously expensive at the market peak in March 2000,
have become quite cheap as 13 years of growth in revenue and
profit have finally caught up with exuberant expectations.
Second, cyclical and political conditions in the U.S. and
Japan are clearly improving, growth in China and most of Asia is
stabilizing at high levels, and stagnation in southern Europe
may matter no more to the world economy than Japan's stagnation
in the 1990s.
Finally, there is the shifting balance of structural forces
discussed here last week. Everyone is now fully aware of the
long-term challenges that investors ignored at their peril
before the 2008 crisis: aging demographics, unsustainable debts,
escalating health costs and so on. But during the crisis years
it was easy to forget about the long-term opportunities that had
excited investors and business leaders in the pre-crisis
decades: the billions of new consumers and producers added to
the global market; the reorganization of the entire world
economy around capitalism and free trade; the new products,
services and efficiencies offered by electronic technology,
bioscience and now unconventional energy.
Nobody can say for sure whether the balance of long-term
trends is genuinely shifting toward these growth-promoting
forces (as I prematurely suggested three years ago in my book
Capitalism 4.0). What is certain is that financial markets
usually detect changes in economic conditions long before most
economists, politicians and investors. By the time the reasons
become obvious for a bull run on Wall Street, it is usually too
late to join in.