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A couple of years ago, as the markets were trying to shake out the cobwebs of the recession and financial crisis, there was a chart in wide circulation that kept a lot of folks out of stocks.
It was dubbed "Four Bad Bear Markets," and was popularized by the blog http://dshort.com. The graph tracked the Dow from four bull-market peaks: 1929, 1973, 2000 and 2007. It, upon superficial inspection, seemed to doom all bounces in stock prices to the category of "bear-market rallies."
The trajectory of the market from the 2007 peak neatly traced the lamentable path of the post-1929 market until the March 2009 liftoff. As Laszlo Birinyi of Birinyi Associates recently noted of this comparative chart, "It was similar until it wasn't." The indexes to date have bested the performance of each of those prior recoveries from a bear-market low.
Yet that similarity to the earlier stretches of market history, which caused investor hope to wilt toward foolishness, has kept speculative expectations in check, to the point where another epochal chart has been required to get investors to believe that the forces of mean reversion favor buyers of stocks.
This chart shows the trailing 10-year annualized total return from large-cap stocks. It dipped into negative territory in early 2009 for the first time since the late 1930s. Obviously, the doubling of the market since March 2009 has made the last decade's stock performance look slightly less pitiable. Upon request, the folks at Strategas Research ran the numbers on what this gauge will read in a few months, if the market stays at the present level as we reach the 10-year anniversary of the post-9/11 market selloff. The trailing annualized decadal return will be 5.4%, nothing special but well up from the 1.4% pace as of the end of 2010.
The truly dangerous moments in market history haven't occurred until the trailing 10-year total return has exceeded 15%, and even in the inflation-vexed secular bear market of the 1970s, the 10-year record mostly hovered between 5% and 10%.
Maybe it's now no longer a slam-dunk, but this slow-moving measure of equity behavior still places the burden of proof on the long-term bears, who in making their argument must adopt the stance of "It's different this time," much as equity bulls argued in the face of the historical record about 11 years ago.
Things are always different than before, the trick being to figure out exactly how and to what degree the differentness is or isn't reflected in asset prices.
Right now, the market skeptics are leaning on the relative lack of trading volume on rallies and the laggardly action in big financial stocks. Yet neither of these is particularly decisive. Indeed, the complaint about the soft performance of financial stocks is reminiscent of quibbling in 2004 that no rally could be legit without leadership by the semiconductor-equipment names. The last bubble's leaders never lead the subsequent recovery, as the 2003-2007 doubling of the indexes (while semis underperformed) proved.
No one can plausibly argue now that consumer and government finances are in great shape. The S&P 500 nearing 1400 seems a fair opportunity either to take money off the table or to wait for a better entry point, pending a new bout of good economic news. And, for sure, corporate profit margins are bumping up against levels that in past decades have augured their decline. Not to mention the abating of seasonal tailwinds as April succumbs to May.
Yet with money free, mid- and small-cap stocks clicking to all-time highs, the takeover and releveraging game gathering steam and investor sentiment refusing to stay excessively ebullient, the downside risk doesn't seem either excessive or imminent.
JOEL GREENBLATT, FOUNDER OF HEDGE FUND Gotham Capital and author of The Little Book That Beats the Market, maintains a free Website at www.magicformulainvesting.com, allowing anyone to hunt for stocks based on his value-investing criteria, which largely rely on companies' return on capital.
A spin through the site last week, in search of companies of at least $5 billion in market capitalization ranked highest by his valuation method, starkly revealed how Big Tech has gone from momentum darling to bargain-hunter favorite in a decade. Nearly half of the 30 highest-ranked stocks are tech names, including Analog Devices (ticker: ADI), CA (CA), Cisco Systems (CSCO), Expedia (EXPE), Hewlett-Packard (HPQ) and SanDisk (SNDK). Maybe this is the market's way of conveying a sector in secular decline, but it's rarely been profitable to avoid cheap, well-capitalized stocks such as these.
Side note: Defense stocks are also conspicuous on this screen, from Harris (HRS) to Lockheed Martin (LMT) to Raytheon (RTN).
E-mail: michael.santoli@barrons.com
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