Just naming certain years in market history can tell a dramatic story: 1929 and 1987 denote generation-defining crashes, 1999 is code for easy-riches mania, 2008 for financial-system collapse.
The year 1995 tends to get lost in the general “late ‘90s bull market” period, yet it was one of the most distinctive years in market memory – a tireless, gentle, seemingly effortless upward glide to a 34% one-year gain for the Standard & Poor’s 500 index.
As profoundly different as today’s economic backdrop might appear, the steady, fear-defying rally of 2013 to date most closely resembles that of 1995 in its rhythm and pace, which is generating a bit of Wall Street chatter about what it might suggest as the possible nirvana scenario for investors.
Jonathan Krinsky, chief technical market analyst at institutional broker Miller Tabak, pointed out to clients this week that 1995 was the only time prior to 2013 when the S&P 500 got this far into a year without at least a 4% pullback, and in each year the index was up about 14% as of May 8.
That old "irrational exuberance"
The market would, in fact, go the entire stretch of 1995 without so much as a 4% drop, slowly building the confidence of investors and inflating stock values to the point that, by late 1996, Federal Reserve Chairman Alan Greenspan famously mused about how “irrational exuberance” might be restrained.
Let’s note the visible contrasts between 1995 and today, which no doubt are leaping to mind and which will reinforce the sense among today’s skeptical investors that the current market rally is unmerited by the fundamentals.
The U.S. unemployment rate spent all of 1995 below 6%; today it is at 7.5% and falling grudgingly. Back then the economy was well into a recovery from a mild and brief recession; now the world economy is healing slowly from a deep and scarring downturn. Corporate profit margins then were healthy and still rising, while today they are already at historic highs.
Yet the echoes between today’s growth-challenged, worry-beset environment and that of 1995 are also pretty clear, and less well-remembered.
Tony Dwyer of Canaccord Genuity has been among the most bullish Wall Street strategists for the past couple of years and has been predicting a jump to 1760 on the S&P 500, which would represent another 10% gain from here. He has been invoking the ’95 analogy for some time, and recently detailed some parallels.
There was an all-out “growth scare” in ’95, with U.S. GDP slipping below 1% for two straight quarters and April and May payrolls declining. “China was slowing from upper-teens growth to upper-single digits,” Dwyer notes, while Mexico nearly defaulted on its government debt, commodity prices were sliding, Western Europe’s economy was stalled, the U.S. federal deficit was at then-all-time highs as a proportion of the economy and the S&P 500 price-to-earnings multiple had entered the year near 15 as it did this year. There are some rhymes there, at least.
The wall of investor worry entering 1995 was also rather high - even if in the popular memory the second half of the ‘90s was all economic giddiness and technological magic. In 1994 the Federal Reserve imposed a brutal bond-market crash in order to head off inflationary pressures. Wall Street firms lost money as a group, bond hedge funds imploded, and it was widely believed the Fed had engineered another recession on a still-fragile economy.
Obviously, today’s Federal Reserve’s love hasn’t been nearly so tough. It has held rates at zero for years and is committed to an unending program of adding tens of billions per month to financial markets through asset purchases.
Yet in the spring of ’95, once Greenspan reversed course and began cutting rates, we had a central bank that was essentially adding fuel to an economy and credit markets that were already gathering pace beneath the surface. Today’s Fed, from one angle, saw the economy and markets stumble each time it has ended aggressive support programs in recent years, and is now determined to stay easier for longer even should the economy accelerate from here.
Damage below the surface
One under-appreciated element of both 1995 and 2013 (to date) is how each represented a great unclenching of bound-up financial and economic anxiety. Wall Street had essentially undergone two crashes (one of stocks, the other bonds) within seven years. Risk-taking had been forcibly curtailed, and even though the S&P 500 showed a slim loss for 1994, the damage below the surface to the typical stock was painful. Washington was a snake pit, warring over budget and social issues, and Congressional Republicans would shut down the government in late ’95.
Entering 2013, financial players had endured a serious meltdown scare either from Europe or Washington for three straight years, and in general investors were defensive, hedged, positioned to expect continued volatility. In both cases, the Street was not in a posture to profit from an “outbreak of calm” in either the economy or policy, and markets re-priced higher than seemed warranted at first.
These historical exercises should never be taken too literally, or too far. The 1995 market was picking up the stirrings of massive economic advances: the commercialization of the Internet, the emergence of Asia, the democratization of finance. (Netscape would go public that year, launching the tech-stock wealth bonanza, and Charles Schwab Corp. (SCHW) started taking online accounts that year.) Any economic downturn in ’95 was likely to be manageable, with lots of policy tools at the ready to address it.
Today the economy is demographically less energetic, monetary policy makers are well into uncharted waters and it’s simply not clear if today’s strong equity market is telling us anything enduring about private-sector progress not yet evident. Stock valuations are getting stretched even as corporate profit margins are likely peaking. And maybe the rarity of the smooth, perfect 1995 rally actually tells us how deeply unlikely a rerun is for this or any year.
Still, the market doesn’t always track headlines or the prevailing mood. The “unclenching” of anxiety could easily carry on for a while in stocks, especially given the way the corporate-bond market is generously pricing risk. While not a prediction, the 1995 market probably represents a pessimistic investor’s “upside risk.”