What year is it?
That seems to be one of the themes that keeps popping up lately. What year is 2013 like? Is it 1999 and we are about to crash? Is it 1982 and we are on the verge of a multi-decade bull run? Or are we heading for a 1987-like debacle?
The answer is none of the above. The circumstances today do not have any exact parallel to prior years or cycles. A quote often attributed to Mark Twain* is that “History does not repeat itself, but it does rhyme.” My favorite rhyme this cycle has been 1973-74. I have referenced that repeatedly during and after the 2008-09 crash. To me, the 56% fall and ~74% snapback rally was hard to argue against as the closest historical analogy.
That is, until ZIRP and QE1-4 began. An FOMC engineered 145% rally off of the lows at a 0% Federal Funds rate is simply a case of first impression. There are no historical analogies to the current circumstances. The Fed action has shifted the context debate into a new dimension.
Now before you go accusing me of saying that phrase, a brief word: Many people seem to misunderstand the context of Sir John Templeton’s famous quote: “The four most expensive words in the English language are “this time it’s different.” I have always interpreted that to refer to the fact that since human nature is unchanging, it is never different this time. But this truism does not mean we should not discern different circumstances that drive investors at different parts of the markets cycle. Facts can and do differ. That has major repercussions — at least over the short-to medium term.
How might the Fed engineering of the post-credit crisis recovery manifest itself? I can imagine three possibilities:
1) Stopping the natural recessions and corrections;
2) Skipping the last 5 years of the secular bear market (Its 1982!)
3) Driving us straight to 1987
Let’s briefly consider each of these.
What does it mean that the Fed has stopped the natural recessions and correction cycles? Here we are are, almost five years post the last recession start — and the economy continues its modest recovery. This is what Reinhart & Rogoff paper — the good one — forecast. FOMC policy is stimulating demand for anything credit-driven. This includes corporate CapEx spending, consumer auto purchases and of course Housing. I do not know of any parallels to these circumstances.
Option 2 is skipping the last 5 years of the secular bear market and fast forwarding us to 1982. Problem is, P/E ratios never quite got low enough and dividend yields never got high enough. However, the credible counter argument is simply low rates removed the expected competition. Without risk-free US Treasuries yielding 14%, the major competitor to equities never materialized. Hence, stocks were prevented from finding their natural floor.
The final option is that the Fed is driving us straight to the 1987 crash. Professional money managers have been forced in; dividend stocks are the new treasuries. Even mom & pop are starting to look at the stock market. The flip side of this is that after nearly 40 months of outflows from equity funds, we now have but 5 consecutive months of modest (at best) inflows. Bond funds are still attracting more dollars.
There are lots of other factors affecting markets: Taxes are low, Asia’s development, contained labor costs, international market expansion, productivity gains, practically free credit. Hence, why I say there are no direct paralleles to the current circumstances in the market’s history books.
You Humans are the same as you have ever been. Your cognitive biases and emotional (over)reactions are no different than they have ever been. But the circumstances in which you make risk/reward decisions, the context of your investing analyses, are vastly different than what we have become accustomed to.
I suspect this change of context may surprise all of us . . .
* There is no actual written Twain quote to that effect; The closest version is “It is not worth while to try to keep history from repeating itself, for man’s character will always make the preventing of the repetitions impossible.” (Mark Twain in Eruption: Hitherto Unpublished Pages About Men and Events, edited by Bernard DeVoto, 1940).