With the major indices hitting new cycle-highs this week, it is safe to say that the current bull market, which began on March 10, 2009, remains intact. Through Tuesday, this glorious ‘run for the roses’ has produced gains of +66.3% on the Dow, +73.6% for the S&P 500, +90.4% over in fourletterland, and a stunning double (+101.1%) for the smallcaps of the Russell 2000. History shows that this has been one of the best first-years for a bull market ever. And the bottom line is that there is no reason to believe that the bulls won’t continue to hold court given the improvement we are seeing in both the economy and earnings reports.
In our last big-picture report, we even presented five reasons to stay bullish and detailed why we believe it is a good idea to give our heroes in horns the benefit of the doubt this year. However, we must also recognize that trees don’t grow to the sky and that the road might become a little bumpier as we go forward.
Happy Birthday – Now What?
With the bulls having celebrated a birthday in March, we thought we’d look back at other bull market runs in history to see what the second year tends to look like. And in the category of giving credit where credit is due, we have to thank the computers at Ned Davis Research for the historical details on the subject.
Cutting to the chase, after a rip-roaring first year, the second year of a bull market tends to slow down considerably. So, for those of you expecting the good times to simply continue to roll, we’ll suggest that it might be time to take a breath.
Compared to the previous 26 bull markets, the first year of the current bull has been a doozie. For example, the median gain for the S&P 500 during the first year of a bull market has been 29.2%. Thus, this bull’s first year’s pop of 69.3% was definitely one for the record books.
However, in the second year, things tend to slow down – a lot. This is likely due to the fact that after sprinting higher in the first year of a bull market; the indices tend to experience a more meaningful correction in the second year.
History shows that the median gain for the second year of a bull market has been just 9.0%, which is a far cry from the 29.2% seen in the first year. What is perhaps even more interesting/important is the chances of the second year being positive are only 69%. Although these odds still clearly favor the bulls, this also means that the second year of a bull market has been negative 31% of the time.
So, while it does appear that the bulls remain firmly in control at the present time, we should recognize that (a) we will likely see a meaningful correction this year and (b) the rates of return we saw in the first year of this bull run aren’t likely to be repeated. This, tells us that being nimble and making good trading decisions is going to be important going forward.
Looking Ahead: What Do the Cycles Say?
While we do not like to use a crystal ball in our work, we also don’t mind having an idea of what might lie ahead. Toward this end, we like to look at cycle composites for various time frames. And while the market doesn’t always follow the cycle composites to a “T”, when it does, the projections can be scary good.
What do the historical cycles tell us about the average year? If you break down the one-year calendar cycle for the Dow Jones Industrial Average, the typical year sees a rally period from January into the spring; a corrective phase from mid-April through June; a summer rally that lasts into late August; a pullback in the fall; and a year-end rally beginning in October/November.
In glancing at the calendar, we see that the mid-April period is fast approaching. And with the stock market having run up +11.1% from mid-February through March 23rd, it is safe to say that the market is overbought and vulnerable to disappointment. Thus, that corrective phase the calendar year cycle calls for might be worth keeping in mind.
What should we expect from the typical springtime decline? While averages are just that, history shows that the declines seen from the April high to the Man/June low tends to average just shy of -9%. As such, traders may want to be on high alert for an end to the current joyride to the upside.
What to Watch For
Perhaps the most important thing to keep in mind when playing the projection game is that markets generally require a catalyst to change directions. So, although the one-year cycle calls for a pretty hefty decline starting in mid-April, unless a “trigger” comes along that provides the bears with a reason to be, it is probably best to continue to side with the bulls. After all, the trend IS your friend.
While a bearish catalyst for a quick dance to the downside can take any form, a topping process traditionally includes an overbought condition (from an intermediate-term perspective), excessive optimism among investors, rising interest rates, and a deterioration in market breadth.
At this point, we can make checkmarks next to the overbought condition and the overly optimistic state of investor sentiment for sure. In addition, we did see interest rates start to rise in earnest last week, which is something we will need to watch going forward. But, the good news is market breadth remains strong at this juncture.
To be clear, none of the above is a reason to sell stocks at this juncture. No, we’ll let our objective models and indicators tell us when it is time to start heading to the sidelines. However, knowing that there is at least the potential for a healthy correction coming in the next couple of months may help us to avoid becoming complacent.
Wishing you green screens,
David D. Moenning
Founder TopStockPortfolios.com
Positions in Stocks Mentioned: None
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The opinions and forecasts expressed are those of David Moenning, founder of TopStockPortfolios.com and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment
