Clem Sunter

1942, 1982 and perhaps 2012

2013-02-08 12:15

Clem Sunter

Notice the pattern. Three different years - 40 and 30 years apart: but what was the significance of 1942 and 1982? Both years were the start of huge bull runs in the Dow Jones Industrial Average: the first took the Dow from 100 to 1 000 in 1966. Thereafter it was flat until 1982 when it ascended to 12 000 in 2000. The first run was a multiple of 10 and the second was a multiple of 12.

Before 1942, the Dow was 100 in 1906, rose to just under 400 at its peak in 1929, fell to 40 in 1932 and recovered to 100 in 1942. In other words, the overall result was flat for 36 years before lift-off in 1942. Between 1966 and 1982, the Dow oscillated between 600 and 1 000 before the second ascension to 12 000.

Why is this relevant? Between 2000 and 2012, the Dow rose to 14 000 in 2007, fell to 6 500 in early 2009 before climbing back to 12 000 in 2012. If you had got your timing right and bought after the Crash of 2008, you would have nearly doubled your money. By contrast, as a long-term investor, you would have experienced a glorious "U" ending up where you started in 2000. The same is true of the Standards & Poor's Index which started and ended at 1 500.

The million dollar question is this: have we had the obligatory resting period as occurred before 1942 and 1982, implying that, based on historical experience, the Dow is now lifting off to a level of 120 000 by say 2030? The strength of the US stock market so far in 2013 - where the Dow has already touched 14 000 - would suggest that some kind of lift-off has occurred as a result of less volatility and better-than-anticipated corporate results. Thus, the second question is: can it be sustained or is this just another rally that will turn into another dip or, worse still, be the forerunner of another crash?

Let's start by going back to 1942 and 1982. Could you have recognised that either year was the beginning of a long-term boom in equities? 1942 was smack in the middle of the Second World War and the tide had not convincingly turned against Germany. Defence procurement was certainly helping America's economy revive from the Great Depression as was recruitment into the armed services. A clever American analyst might have spotted the turn, but would have had to have made the assumption of victory in the war (though of course Germany and Japan as the losers also made an incredible comeback in the 1950s).

1982 was in retrospect the year when another battle turned in favour of Western governments, this one being the battle against raging inflation. It did not take long to get down to reasonable single digit figures, but there was one characteristic shared between 1982 and 2012: negative real interest rates. Nobody wanted to keep money on deposit at banks or invest in triple-A bonds then and the same applies now as it is a recipe for losing the purchasing power of your wealth. Yet the driving forces behind the extended boom in the 1980s and 1990s were also the rise of the East and the IT revolution which produced the PC, the internet and the mobile phone.

So, beyond negative real interest rates, what other factors could sustain a long-term ascent in the Dow post 2012? I think the biggest plus is the possibility of another technological revolution but this time centred on improving energy efficiencies and coming up with completely new sources of energy. I would not be surprised if home-based solar energy systems, providing all the electricity needs of a household, will by 2030 be as common as mobile phones. Equally, the rise of the East may be supplemented by the rise of the South i.e. South America and Africa.

On the minus side, two major restraints on the Dow accelerating upwards over time exist. First, and weighing heavily on any major recovery, is the megatrend of ageing populations in Europe and Japan and later down the line the demographic cliff faced by China as a consequence of its implementation of a one-child policy in 1978. America, India and other members of the developing world, still have relatively young, growing populations which may to a certain extent offset this megatrend. The second downer is the fact that most over-indebted countries including America have made no inroads into correcting their budget deficits and reducing their national debt-to-GDP ratios. At some stage, action has to be taken or else another financial panic will ensue which this time is caused by worthless sovereign debt as opposed to sub-prime mortgages.

The markets are betting on a "Goldilocks" strategy in the US where the cuts are fine-tuned to a point that the problem is resolved without choking off economic growth. The porridge is not too hot and not too cold. It is definitely a flag to watch. Meanwhile, I believe the best approach to managing one's wealth is to have one-third in cash and bonds, one-third in physical property and one-third in equities (something my father taught me). Every two years, you reduce the category that has outperformed the others and increase the ones that have underperformed so you are back to a third, a third, a third. By all means, pick your own review period - some people prefer five years.

Essentially, this method mirrors Warren Buffett's advice to be greedy when others are fearful and fearful when others are greedy, because you are selling stuff that has done well and buying stuff that has done badly. You are diversified and contrarian at the same time. You will never do as well as a hedgehog who bets everything on a bull run and is right. Nevertheless, by being a fox, you will never do as badly as a hedgehog who is proved wrong.



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