Last year Wall Street flashed back pleasantly to 1995, a year of relentless ascent for stock prices, supported by a determined Federal Reserve and broadening faith in a healing economy. Investors looking for a suitable playlist for 2014 might want to skip ahead a decade to 2005, a year of sideways churning in which stock indexes digested big gains, and market pros searched for the next growth catalyst as Fed policy turned less generous.
The past, of course, is never perfect prophecy, no matter how carefully one listens for the rhymes. But patterns and rhythms at roughly similar points in a market, economic and public-psychology cycle tend to be similar, and can offer a rough analog to current times.
A year ago I pointed to the 1995 similarity as a possible upside scenario, based on the multi-year cloud of gloom and doubt lifting and investors re-embracing risk through stocks. That tune tracked pretty well, with both ’95 and ’13 logging 30%-plus returns in the Standard & Poor’s 500 index without dramatic pullbacks, powering a surge in investor optimism.
Consider, for 2014, several familiar elements of the 2005 tape:
The market spent 2005 digesting a rapid advance that began more than two years earlier, at the bottom of the tech-bust bear market. By year-end 2004, the S&P had gained 52% over the prior 28 months. The index finished 2013 at the 1,848 level, having risen 63% over 28 months, dating back to the time of its last double-digit drop (of about 19%) in mid-2011.
Having finished last year at a record high, the S&P 500 has seen some stumbles and has struggled to stay even for 2014, even as it threatens this week to return to record levels set in March.
It has been a less-inclusive, two-way market so far, with a bit more day-to-day choppiness, and a perceived lack of clarity about the interplay among economic data, corporate results and monetary policy. That’s how 2005 played out; the market fell no more than 6% from where it started, reaching that low in April. At its high print that year, in December, the index was up just 5%.
Adam Warner – options trader, volatility-trading expert and writer for Schaeffer’s Investment Research – has been suggesting in recent months that a choppy “churning” year like ’05 wouldn’t be surprising, jumpy from day to day but with volatility contained by frequent switchbacks.
The hefty gains in a short period of time entering 2005 had stoked animal spirits enough that some feared a “new tech bubble” had emerged, led by Google Inc. (GOOGL, GOOG), which went public in August 2004 and saw its stock triple by the spring. The Economist headlined an article “The Echo of a Boom?” in June 2005, just as early this year articles warning of a “New Tech Bubble” proliferated.
In both years, overheated tech stocks pulled back hard, falling 12% by Memorial Day, even as the broad market held relatively steady. Small-cap stocks also underperformed in the first part of 2005, as they have so far this year. Also, in both years, sloppily exited crowded trades caused air-pocket declines and rising anxiety.
A Barron’s-column lead of mine from May 2005 could’ve been written last month (and not just because I often repeat myself): “The rushed unwinding of some of the trendiest trades among hedge funds and their brokerage-firm enablers tossed around the stock market last week, knocking the major indexes back within one nasty afternoon's selling of their [year-to-date] lows.” In '05 it was commodity, emerging-market and industrial names, recently it was Internet and biotech darlings, but the action was similar.
A Google Trends search shows popular anxiety about a potential stock-market crash was fast on the rise in early 2005 (three years before it came), just as it has been lately.
The Fed back in '05 withdrawing the heavy dose of easy-money stimulus it had administered to the economy in the early 2000s, lifting short-term rates methodically at each meeting from historic lows back toward “normal” levels. Then-Chairman Alan Greenspan signaled he was set to retire; the hope was to have the steady rate-lifting process be clearly articulated and well underway when Ben Bernanke took over in early 2006.
Granted, today’s Fed, under new Chair Janet Yellen, isn’t close to lifting rates from the post-crisis “zero bound,” but it is methodically reducing its asset-buying in a clearly articulated manner. Markets are adjusting, with some anxiety, to the process and are highly sensitive to economic data that call the preset policy path into question. The 10-year Treasury yield spent most of '05 rangebound above 4% as the yield curve flattened, reminiscent of the recent bond-market flattening dynamic.
The corporate-profit recovery was quite mature by 2005, with S&P 500 company earnings having more than doubled from a few years earlier and average profit margins sitting near a then-record high. This presented a perceived headwind to further earnings growth and a lack of obvious fundamental catalysts for market gains, given that overall price-to-earnings multiples showed stocks were far from cheap.
That pretty much describes the current market moment, except that now the earnings gains to date have been even more dramatic, margins are higher than ever before and even published Wall Street aggregate forecasts call for unimpressive profit progress.
The broad stock market did nothing much from the start of 2005 until mid-2006, when the Fed quit raising rates, the blow-off phase of the credit-and-housing bubble began, and financial engineering and private-equity deal-making went wild for about a year – until it all started to fall apart in ’07. Would it be a shock for the market to mark time for a while now, then start flexing its silly muscles in a final bull-market bash?
Before firing off reflex objections about how vastly different the world is today versus 2005 – of course it is. Yes, the economic slump was deeper this time, the employment situation worse, central-bank intervention more extreme, and the market itself has mounted new highs rather than simply making up ground lost a few years earlier, as in '05.
But markets metabolize imperfect information in a similar manner across the ages, so there’s merit in at least respecting the similarities when they seem to be piling up.
So does this mean that Wall Street is in for the kind of sideways slog it lived through nine years ago, a “mutually assured frustration” sort of backdrop that, over many months, either allows economic fundamentals to catch up to stock values or the market to succumb to weaker macro conditions?
There’s no way to say for sure. But if that’s how things play out, you can now say you saw it coming all along.
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