Happy Birthday, Bull Market

02/23/2010 12:00 pm EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, president of Stack Financial Management and InvesTech Research, says the bull market probably has a way to go before it ends, if history is any guide.

In [a few] weeks, this bull market will be celebrating its first birthday party—that is, if it hasn’t already expired (which we doubt).

It’s not that bull markets can’t end in less than one or two years. But the last time one ended with less than 12 months’ duration was during the Great Depression in 1938. And one hasn’t ended in less than 24 months (two years) since 1947—over 60 years ago.

It’s not only the historical odds that are in our favor, but we still feel that technical and economic odds also suggest the bull market has further to run.

Unfortunately, the Federal Reserve will have to soon start implementing an “exit strategy” from its ultra-easy 0% interest rate policy. And while leading inflation forecasting models are not flashing red, they’re certainly moving into the yellow (danger) region.

In other words, we don’t want to count on this bull market rivaling the five-plus-year life spans that four of the past five bull markets have enjoyed. And if Fed Chairman Ben Bernanke doesn’t pull the right levers at precisely the right moment, then this bull market could turn out to be shorter than the median (44 months) of the past 80 years.

Every bull market of the past 80 years has experienced at least one 10% correction before reaching its final high. One important fact is that if one was “stopped out” on that first 10% correction, they would have left an average 77% profit on the table.

And on average for those 15 bull markets of the past 80 years, a 5% correction has come around every eight months. So, if there’s one thing you can say about the typical bull market, it’s that a correction is always imminent.

In today’s bull market—at barely one year of age—we’ve already experienced five separate corrections of 5% or more. The current correction, at -8.1%, has been the largest.

In the current bull market, corrections have come far more frequently than during the early years of the 2002-2007 bull market. But don’t be surprised if we might be in a six-month consolidation period similar to the first half of 2004.

Yet our experience from the 1990 bull market, as well as the 1987 bull market, suggests that the more frequent the corrections, the more quickly the market is able to recover to new highs.

Bottom line: Corrections are a normal and healthy part of every bull market cycle. It’s virtually impossible to “time” them, and can be harmful to profits by attempting to do so. That’s why we don’t worry about corrections. Instead, we focus on watching for potential bear market warning flags that would signal a longer-term downturn or significant portfolio losses.

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