Seeds of a New Boom for Stocks?

Floyd Norris of The New York Times has an interesting article out this week detailing a clear cycle in the history of our stock market. Normally, assuming market cycles are meaningful or predictive of the future is a fool's game -- most of what we think are patterns are just coincidences of randomness. This one, however, makes sense, and investors should pay attention to it.

As Norris explains, for the past half-century the market has moved in 15-year cycles where returns swing from spectacular to near-zero. In 1964, the average real return over the preceding 15 years was a stellar 15.6% a year. Then it flipped. By 1979, the previous 15 years produced a negative real return. Then it flipped again. By the late 1990s, 15-year average returns were near record highs. And again: As of the end of last year, stocks returned a measly 3% a year over the last 15 years.

The trend is clear: After booms come busts, and after busts come booms. And that doesn't happen overnight. These cycles tend to last over a decade.

That bodes ill for stocks, Norris writes. "If past is prologue, the 15-year return is likely to continue to decline and to turn negative in about four years. That does not necessarily imply that stocks will fall during that period, since that could happen with small gains over the period."

That's one way to look at it. Another is the realization that, after more than a decade of negative real returns, there's a decent chance that we're fairly close to the beginning of a new bull cycle.

Sound crazy? It sounded crazy in the early 1980s, too. So did the notion 10 years ago that we were about to face a decade of stagnation. So did the idea in 2006 that home prices were about to fall by half. As did the idea in 2009 that stocks were about to double.

That's always how these things work. The tide turns when everyone least expects it. The more obvious the market's direction seems, the greater the odds that you're wrong.

One thing is certain: We are exactly 10 years closer to the next bull market today than we were 10 years ago.

Here's how this looks historically:

Sources: Yale University and author's calculations.

After booms come busts, and after busts come booms. Happens over and over.

Going back to 1820, stocks have never produced two consecutive decades of real losses. After a decade of losses (like we just experienced), the worst subsequent 10-year return we've seen is about 12% a year. That's a hefty return by any measure.

Of course, history isn't guaranteed to repeat itself. And what drives stocks to a decade of low or high returns isn't the calendar; it's valuations. Stocks do well after they're cheap, and poorly after they're expensive. So the real question shouldn't be how long stocks have been stagnant, but whether they're cheap.

That's a matter of constant debate. I recently interviewed two heavyweights in the finance field: Wharton professor Jeremy Siegel and Yale professor Robert Shiller. Siegel thinks stocks are undervalued by as much as 25%, and priced to set investors up for a boom going forward. He cites below-average P/E ratios, low interest rates, and an economy that's stronger than most give credit. Fears that corporate earnings are in danger of falling are overblown, he says. The fact that U.S. corporations do more of their business overseas lowers the odds of a lasting earnings bust -- business is more diverse than it was in the past.

"I think stocks are going to beat their historical average" going forward, Siegel told me. "Their historical average returns are between 6% and 7% per year after inflation. I think we are looking actually at probably 8% to 9% per year after inflation over the next five years, 10 years."

Robert Shiller isn't so sure. His metric, a P/E ratio using an average of 10 years' earnings, show stocks might be a little overvalued. Earnings also look unsustainably high in his view, though he's somewhat sympathetic to the idea that investors are suffering from pessimism. "I would say in some senses we do have too much pessimism right now; in other senses, no. I mean, the stock market only briefly in 2009 got below its historical average price/earnings ratio. Now it's kind of high," he said.

But when I asked Shiller about another topic -- gold -- he mentioned something that seems particularly relevant to the stock market today: "I think when you look at history and a broad set of facts to make judgments about speculative assets, you also have to correct for your natural biases. You have to think that I am likely to overreact to a decade of price increases and become too optimistic."

And concurrently, you have to think that you're likely to react to a decade of price decreases in the stock market and become too pessimistic.

Whether stocks will have a great decade, no one knows. Anything could happen. I happen to think the odds are decent that they will; others think the opposite. That's what makes a market.

What about you?

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (14) | Recommend This Article (33)

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  • Report this Comment On January 10, 2012, at 6:31 PM, xetn wrote:

    We can all rest easy now; and we don't even need to check up on are stocks. Just listen to the "genius" at the NYT. Its all just cycles.

    This is partly true in that the Austrian Theory of the Business (trade) Cycle proves that with large increases in the money supply with resultant reductions in interest rates below what the market would generate causes the booms and resultant busts.

  • Report this Comment On January 10, 2012, at 7:35 PM, Kiffit wrote:

    It all depends on where you think you are. As the Empire declined and became less secure, big Roman landholders diversified their holdings and fortified their houses in a process of defensive investment. It didn't save them in the end, but then nothing does.

  • Report this Comment On January 10, 2012, at 8:38 PM, devoish wrote:

    Where is the money to invest in stocks going to come from?

    Home equity loans? rising wages? decreasing student debts? lower cost of living? refinancing debt at lower rates? Social Security? rich people with nothing else to spend on? defined benefit plan investing? optional 401k's? Is there enough lendiing outside the US to grow our stocks?

    It is not different this time. It is different every time.

    Best wishes,

    Steven

  • Report this Comment On January 10, 2012, at 11:08 PM, FutureMonkey wrote:

    "I'll spend most of it on irish whiskey and fast women. The rest, I'll probably waste" -- Tug McGraw.

    Up, down, sideways. I put the same dollar amount away every month. It's either that or stock the larder for the coming zombie apocalypse or climate disaster. Balance, steady-eddie investing in diversified assets that produce cash flow seems to be a smart play in a secular bear or bull market. Either that or go with Tug's idea - which works well in case of Bear Markets, Bull Markets, or Zombie Apocolypses.

    FM

  • Report this Comment On January 11, 2012, at 12:12 AM, incomeplease1 wrote:

    History might not be guaranteed to repeat itself, but if you like betting the odds using history, then bet the market is going higher. I had never heard of this take on the January barometer before:

    http://seekingalpha.com/article/318507-history-says-stocks-t...

  • Report this Comment On January 11, 2012, at 1:30 AM, Risky88 wrote:

    stocks go up and down

    up and down

    and....

    up and down some more

    its what they do

    and they do it well

  • Report this Comment On January 11, 2012, at 11:08 AM, ouchtouch wrote:

    Show me what happened to stocks the last time we had a global debt bubble this big. Oh, right, it has never happened before. We are a very very long way from the bottom.

  • Report this Comment On January 11, 2012, at 11:49 AM, bherber wrote:

    It will depend on whether Congress will have the resolve to reduce national debt by tackling the two biggest components - Medicare & Social Security. SS can easily be fixed by lowering the retirement age, and gradually reducing benefits. I'd rather have a working system that pays out less, than no system at all.

    The third biggest component is interest on the national debt.

    Also a big factor will be whether the tax code will be reformed and the top tax rate reduced from 35% to something lower which would incentivize more corporations to keep money here. The U.S. has the second highest top income tax rate, next to Japan (39%)

  • Report this Comment On January 11, 2012, at 12:04 PM, NeuroProf wrote:

    That's what makes a market.

    And when people can bet on up and down and make money either way, the one things that's guaranteed is volatility.

    Cash flow and gold never looked so good to me.

  • Report this Comment On January 11, 2012, at 12:16 PM, kirkydu wrote:

    I've been talking about this extensively for about five months now. While deflationary forces still abound, they are abating, slowly. Stocks will recognize the shift ahead of time and rally.

    http://kirkspano.com/content/category/1/1/83/

  • Report this Comment On January 11, 2012, at 12:41 PM, DJDynamicNC wrote:

    Consumer credit (not limited to credit cards, btw) expanded drastically in November of 2011.

    Housing starts are at historic lows while population growth rates continue or even increase.

    Deleveraging has been consistent since the crash and is having measurable results.

    Obama looks poised to win in 2012 (historically, the economy performs much better under Democrats than Republicans - you can argue the reasons all you like, and I am sure some of you will, but the simple mathematical fact remains).

    Corporations sit on record cash piles.

    Taxes are at all time historic lows.

    That all adds up to a potent upwelling of demand in the economy, which is what we've been lacking (no business owner hires more people because of tax cuts; we hire people because there are customers who need our services and we want to fill that demand).

    Now, we're not out of the weeds yet, but barring major policy errors from the Fed or more economic sabotage from Republicans determined to win the Presidency at any cost and I'm long on the US economy for the next decade. And that bodes well for stocks. There's a reason I keep bumping up my monthly investment totals.This trough won't last forever.

  • Report this Comment On January 11, 2012, at 5:51 PM, reddingrunner wrote:

    I seem to remember Buffett talking about 17 year cycles and even predicting in 1999 or so that the market would do poorly from 2000- 2017.

    If valid, the cycle makes sense psychologically.

    Each generation would be marked early in their experience by either euphoria or fear and that emotion would continue to dominate their investing until such time as market values were so misaligned with intrinsic values that finally a new cycle would begin and a new generation of investors would be emotionally marked in the opposite direction as their predecessors.

  • Report this Comment On January 11, 2012, at 6:17 PM, seattle1115 wrote:

    @ bherber: "Also a big factor will be whether the tax code will be reformed and the top tax rate reduced from 35% to something lower which would incentivize more corporations to keep money here. The U.S. has the second highest top income tax rate, next to Japan (39%)"

    Can someone please explain to me how marginal *personal* income tax rates can possibly incentivize *corporate* behavior? Further, perhaps you could give me some idea how much capital fled the country during the long postwar boom, and what the top marginal income tax rates looked like during those years.

  • Report this Comment On January 12, 2012, at 2:15 PM, DJDynamicNC wrote:

    Seattle1115: +1 to that.

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