The Market: May 2018

I chose the cartoon for this month to provide not only humor but also a clue to figure out when this bull market will end.  Market cycles, to a large extent, are based on psychology and participation.  Bottoms occur when everyone is pessimistic and no one wants to own the particular asset.  Conversely, when everyone is excited and everyone has crowded into an asset class, a top is near.  Recall not long ago oil prices were falling and analysts were calling for a protracted bear market with prices per barrel potentially going into the teens. One popular commentator said that oil, “Would not go above $50 in my lifetime.” Well, a year after this prediction, oil is now $75-$80 per barrel.  Our squirrel friends are examples of when we should be worried about stocks. It’s when investors and pundits start saying that stocks will go up forever and predictions like Dow 100,000 hit the headlines, the bear is coming.  When you read stories of more and more people quitting their jobs, like Mr. Squirrel, to trade the market, clouds are on the horizon. In late bull markets, investors clamor for ever more risky stocks a la dot-com companies in 1999 where companies with no revenues and often no employees were richly valued.  I don’t think we are there yet. Since the 2008 financial crisis, investors may have been buying stocks but have done so warily and without enthusiasm.  There have been some high profile IPO’s but nothing close to a mania. There is data that shows that many have not gotten back into the markets even though 10 years have passed since the 2008 debacle.   The Crisis is still fresh in people’s minds. Now one could argue that there are other assets that have absorbed the market’s speculative tendencies. The cryptocurrency phenomenon comes to mind as do the high prices in commercial real estate and in the large flows to private equity and venture capital partnerships. There may be an argument that there are more asset classes than in the past for speculative money to flow and that stocks are less exciting and therefore the bull market in stocks can last longer.  In the first instance, markets go down not due to selling pressures but rather the result of everyone who is going to enter the market being in, leaving no one left to buy more.  The rock begins its roll down the hill due to its own weight. Once the market heads down, then the selling comes in.  As long as there is  appetite for stocks and there are buyers to come in, the bull run can last.  The Nasdaq Index gained 22% in 1997, 40% in 1998 and surged 86% in 1999 before the 2000-2002 bear market.  History may be a guide and we will see a big, blow off top like we did in the late 1990’s where buyers get sucked into the surging markets in big numbers before we reach the top of this bull market. If a big move up does occur, it may not be of the magnitude we witnessed in 1999 but it may nevertheless serve as a warning. — Ian Green, Pendragon Capital Management