Dear Bull Market: Happy 10 Year Anniversary

It’s been almost 10 years since this bull market began. What an incredible run. Despite all the doom-and-gloom news reports, this bull market has been impressive. (And no, it’s not because of “evil government manipulation”).

To put this into perspective, someone who bought at the top in 2007 would still have doubled their money (after including dividends reinvested).

 

Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

 

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

10 years

Here’s the S&P 500’s 10 year-rate-of-change. We accounted for dividends reinvested and inflation: 2 important factors that many market researchers often forget to include.

 

You can see that the S&P’s 10 year rate-of-change is extremely high right now, matching that of the late-1920s, late-1950s, and late-1990s. Suffice to say, the next decade probably won’t be as good for buy and hold investors as the previous decade.

Is this immediately bearish for the stock market?

No.

Here’s what happens next to the S&P when its 10 year rate-of-change exceeds 250%.

 

As you can see, a blow-off top is more likely.

I want to caution readers about a popular chart that’s been going around financial media recently.

Here is a chart of the S&P (inflation-adjusted) and its log-scale regression.

 

On the surface, the S&P seems to be the 2nd most extended from its regression in history. The only other period of such extension? The dot-com bubble.

This chart is extremely misleading because it looks at the S&P instead of the S&P’s Total Return Index.

Re-examine the above chart. The S&P looks like it went nowhere from 1880 – 1950. How can this be?

  1. Why did the S&P “go nowhere” from 1880 – 1950?
  2. Why did the S&P go up from 1950 – present?

The S&P 500 Index excludes dividends. Dividend yields were much higher pre-WWII than post-WWII. Hence, investors in the S&P received most of their gains from 1880-1950 via dividends, whereas investors in the S&P received most of their gains from 1950-present via capital gains.

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Our discretionary outlook does not reflect how we trade the markets right now. We trade based on our quantitative trading models. When our ...

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