How Much Further Can This Bull Market Go?

If it survives another 155 trading days without experiencing a significant drop, the present bull market in the Dow Jones Industrial Average (DJINDICES: ^DJI  ) will surpass that of the 2002-2007 subprime-mortgage bubble as the fifth-longest bull market since 1896. In just more than 1,100 trading days, the index has grown by nearly 140%, better than all but six other bull markets -- and it's within striking distance of sixth place, which would be in reach once the index's value approaches 16,000 points.

One recent analysis by LPL Financial suggests that this is the strongest bull market since the end of World War II, at least in its first four-odd years of growth. Since only four other bull markets have even survived as long as this latest one since 1945, it's not all that hard to make the comparison. But this limitation is a bit restrictive. We should look a little further back at the Dow's century-plus wealth of data to see how all bull markets of similar or greater length have performed in their first four years. This bull market is widely regarded as one of the least trusted in modern investing history, but is that justified, or are investors scared for no reason?

Let's start by looking at how today's market stacks up against its forerunners in growth terms:

The current four-year bull market is hardly unprecedented, but it doesn't have a lot of competition for sheer strength. The Depression-era rebound is a definite outlier (a 90% drop is liable to produce an outsized rebound), so we really only have three analogues for today's market: the Reagan-era boom, the wartime bull market, and the Roaring '20s. Of these, only the Roaring '20s continued for much longer than four years before running out of steam.

It's not enough to understand what has happened; we should also try to understand why these gains occurred in order to gain a better sense of whether this bull market will keep charging. Let's take a look at how GDP growth progressed during the first four years of all other bull markets of similar strength. We'll even toss in the subprime era for a more recent comparison:

Real GDP growth has been pretty disappointing over the last four years. But then again, GDP growth isn't always the best indicator of market returns. Devastated crisis-era corporate profits have already staged by far the strongest recovery of any bull market in Dow history: Since March of 2009, corporate profits gave grown by more than 1,000%, which is more than four times the growth seen in the next-largest increase in the Dow's history. That has kept marketwide valuations, as represented by Robert Shiller's cyclically adjusted P/E, or CAPE, from rising too rapidly. This metric is a much better way to assess the sustainability of a bull market than GDP, but it's also hardly a perfect indicator. We have to start somewhere, though, and the CAPE is our best bet. Is the market's present CAPE flashing a warning? Possibly:

No comparably brisk bull market has ever started from so high an initial valuation, and only one experienced greater cumulative CAPE growth during its first four years. We can't truly compare 1932's bull market to our present situation, as it started from utter devastation -- even with returns nearing 400% for its duration, that bull market only came up to about half the ultimate high-water mark set by the Roaring '20s bull market. If the subprime crash had caused damage similar to the Crash of 1929, the Dow would have ended up at about 1,700 points. Nor is the subprime bubble really that similar to our present situation, as it started from a much higher valuation and experienced less aggregate valuation growth before petering out.

Things may be different in CAPE terms. This valuation has historically only topped out above 20 when it's nearing a spectacular crash, but ever since the dot-com bubble, this has been more of an accepted range than an unusually high level. In fact, the market's CAPE has never been as consistently high as it has been over the past decade. Even the CAPE peak of 1929 was only about 35% higher than today's levels.

There may be reasons to keep the faith in this market, though. Housing has been so depressed for so long that it's bound to pull the economy higher, or so the thinking goes. Consumers aren't leveraged up to their eyeballs any more -- debt only comes up to the chin this time. Unemployment is falling.

But is it falling far enough?

Although the unemployment rate started off at a higher level during the 1982 bull market, our current "jobless recovery," so to speak, has no parallel in postwar times. Is this time really different? Can the market sustain its gains without a substantial further improvement in the workforce? Since the end of World War II, every monthly instance of unemployment greater than 7.5% has occurred either in the middle of a bear market or within the first two years of a bull market. At four years of 7.5%-plus unemployment, in the middle of a market rally, we're in uncharted territory. You can certainly find plenty of reasons for further optimism -- but there are lots of reasons to remain cautious as well.

If you'd like to learn more about market cycles, including what makes them tick and how they can be affected by valuation, the economy, inflation, and other factors, click here to check out a complete illustrated guide to bull and bear markets, with data on every major and minor market cycle dating back to 1896.

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