Market History: Secular Cycles - Part 3

Hi, everyone. For many, the market volatility persisting over the past decade is disturbing. Will we see better times ahead? Let's get on with this part of the analysis on historical market cycles.

# 1980 - 1999 : Secular Bull Market

Since 1965 when President Johnson increased deficit spending to fund the Vietnam war, inflationary pressure began building. The collapse of the Bretton Woods system, the de-linking of USD to Gold in 1971 and the consequent oil crisis in 1974 and 1979 further fuelled inflationary pressures. Soaring oil prices compelled many American businesses to raise prices. Food harvest failures around the world at this time led to soaring prices on the world food market. High inflationary expectations led to a self-fulling cycle of higher prices.

By early 80s, runaway prices pushed inflation to 13.5% while unemployment rate reached 9.7%. US was experiencing stagflation. To wring inflationary expectations out of the system, Paul Volcker was nominated by President Carter as Chairman of Fed and he decided to put the nation through an intentional recession by raising rates. Fed's discount rate went to as high as 14 percent in 1981. Prime rate in the US hit a record 21.5% around that time.

By 1982, inflation abated. The war against inflation was won. Monetary policy was substantially eased and President Reagan introduced tax cuts and continued with deregulations. Within months, the economy roared to life and took off on an expansion that would last 7 years - the greatest peace time expansion in US history.

Geo-politically, the Cold War came to an end with the collapse of Soviet Union. In the middle-east, Iraq invaded Kuwait that led to a subsequent US invasion on Kuwait and attack on Iraq.

One notable market crash occured this period was The Black Monday crash. In a single day, the Dow fell 22.6%, wiping out $600billion in market capitalisation. The prior bull market had been fueled mostly by hostile takeovers, leveraged buyouts and "merger mania", a believe at that time that companies could grow exponentially simply by purchasing other companies. Consequently, there was a scramble to raise capital to finance these buyouts including issuing junk bonds to the public. Many shady IPOs were proliferating while investors were caught up in a contagious euphoria punting on these companies disregarding their true valuations. Insider trading was becoming rampant. Seeing a growing inflationary concern, the Fed began raising short-term interest rates to temper the economy and stock market. The barrage of SEC investigations and crack-down on insider trading further rattled investors who decided by October to exit what they now believed to be a rigged game and move into more stable fixed income securities (whose yields rose from just 7.4% at beginning of 1987 to over 10% in the summer before the crash). While some attested the crash to program trading, portfolio insurance, proliferation of derivatives, market illiquidity and over-valuation, these are really structural issues that would not trigger the panic selling. Rather the market was responding to failings in regulatory regime and congressional policies that undermined market integrity resulting in loss in investor confidence culminating in Black Monday.

The 1990s were also boon years for the economy. Helped by increased tax receipts as a consequence, President Clinton achieved a surplus budget which reduced the debt burden accumulated under the Reagan and Bush years. This helped keep interest rates low arising from reduced government borrowing which in turn spurred the economy. The economic boom of the 1990s was the longest sustained period of growth in American history. Unemployment and inflation fell to their lowest levels in 40 years. The stock market soared on the back of the dot-com boom, wages rose, crime rates fell, and the number of people on welfare declined.

Over this 20-year period, the US economy grew over 3.4 times larger, market EPS quadrupled and S&P soared from 140 to 1500 (over 10 times).

During this secular bull market, there were a few market corrections.

(a) Correction A - 1981 - Paul Volcker bitter medicine

      - Market declined 28% over 20 months
      - Full recovery took 3 months

(b) Correction B - 1983

      - Market declined 12% over 16 months
      - Full recovery took 6 months

(c) Correction C - 1987 (Black Monday crash)

      - Market declined 32% in 1 month
      - Full recovery took 22 months

(d) Correction D - 1991 - pre- Iraq / Kuwait war

      - Market declined 21% in over 3 months
      - Full recovery took 4 months

(e) Correction E - 1998

     - Market declined 25% in over 3 months
     - Full recovery took 2 months

Nonetheless, secular bull markets tend to be resilient with shallower corrections and generally shorter recovery periods. In the next posting, we will examine the most recent 10 years in this new millenium and postulate where we will go from here in the coming years.