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As the autumn colors grow vivid and Northeastern nights chilly, August can seem like a long time ago.
Reading an August market dispatch after the financial markets have pulled dramatically back from the brink deepens this sense: "Wracked with worry over economic crises [overseas], and fearful that the trouble will continue to spread, investors last week drove the bull right out of town. The [Dow] has slipped 13.8% since peaking in July. Thus, we can put an end to the debate about whether we're having a correction and move on to the more sobering question: Are we in an honest-to-goodness bear market? It certainly feels like one."
That was how the late-summer financial panic was described in Barron's Trader column—in the issue of Aug. 31, 1998.
INVOKING THE 1998 MARKET as a relevant analogy for today's situation is, perhaps, an exercise in donning bull goggles, the kind that make every scary selloff look like a delusional bout of negativism and a gift of a buying opportunity. That nasty, if brief, tumble was indeed sparked by runaway fears of sovereign-debt stress (in Southeast Asia and Russia), which expanded into fears of massive bank and hedge-fund losses and liquidations.
Of course, that episode was a mere interruption of a powerful bull market, abetted by investors' lusty risk appetites, a tech bubble in the making, strong Western government finances, better domestic economic momentum, and a Federal Reserve with monetary ammunition and public credibility to spare. Not exactly a description of the present market moment, is it?
Yet, in certain key respects, looking at '98 is helpful. The main one is the prospect that this year's downturn from the springtime highs and, especially, the minicrash of the summer, were more about financial stress and fear of policy missteps than reliable signs of serious and imminent economic contraction -- whether here or globally. The domestic economic numbers have steadied, undergirding the stark outperformance of consumer-geared sectors.
If the current vague sense that things are steadying—as European leaders are finally mustering the nerve and political cover to marshal more bank capital injections—holds, then there could be more eventual market gains in the fourth quarter.
That's something like the current take of the Streetwise column's "mystery broker," who, when last heard from, was looking for a "retest" of the August lows in October before a rally arrived—which is pretty much the way it went. He figures the year's lows are in the history books, and if we get some sideways-to-modestly-down digestion in the indexes, he believes the market will be a fair bit higher by New Year's, much as happened in late 1998.
Maybe the most striking thing about conjuring that year is the realization that, in its fourth quarter, the S&P 500 first surmounted 1200, the level that it has been crisscrossing for much of the past year.
The fact that we are struggling daily to hold above a level first reached nearly 13 years ago is both sobering and, viewed in the proper light, profoundly encouraging for true long-term investors. Henry McVey, Kohlberg Kravis Roberts' head of global macro and asset allocation, suggests in a new white paper that "we are finally returning to a time of 'stocks for the long run'….Anyone who believes in mean-reversion investing has to consider the current starting point for equities at least somewhat attractive."
That doesn't make McVey a snorting bull; he thinks investors should accumulate stocks aggressively if the S&P 500 gets below 1050, and views around 1250 as "fair value." Jim Paulsen of Wells Capital was kind enough to calculate the 10-year forward return from all points in history when the market was flat or down over the prior 12 years. The result: a 7.2% annual gain, versus 4.7% for all other times, not including dividends.
IT'S NOT OFTEN that a major stock market trading in a place first hit a dozen years ago falls apart in a devastating way. Typically, when the past decade's equity returns were flat or negative, the following decade offers decent to above-average results, as valuation excesses have been ground down and the public has soured on stocks, both conceptually and in its actions. Note that even at the panic lows of '98, stocks were about twice as expensive as they are now.
Other periods in which stocks in a prolonged "secular" bear market sat at a level first reached 13 years earlier include the early 1940s and the late 1970s. These were not wonderful moments to gorge on stocks for a short-term killing, and, like today, were periods cursed with daunting macro challenges (lots of wars, rampant inflation). But they were closer to the end of the asset class's long malaise than to the beginning. By those points, the earlier bear-market lows were never again approached, and the market ended up paying off pretty well for investors over the ensuing decade and more.
Comments: E-mail: michael.santoli@barrons.com
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