A Bull Market That's Short and Sweet

04/20/2010 12:30 pm EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, editor of InvesTech Research, says this unloved bull market is likely to continue for a while longer, but it may not be long and the gains may be muted.

From the very beginning, this has been one of the most unloved bull markets in history. Fear, skepticism, and doubt have kept many investors on the sidelines. And even a full year into the bull market, that hasn’t changed much.

In a frantic search for better (or safer) returns, investors poured $421 billion into bond mutual funds last year, and another $90 billion in the first quarter of 2010. Personally, we think this “flight to bonds” could be a bad mistake at the worst time. While one can get 4% to 5% from buying ten- to 30-year Treasury bonds, those yields quickly disappear into capital losses when yields start rising.

After three decades of falling inflation and bond yields, it’s difficult for us to envision anything but higher rates in coming years as the US struggles to finance the projected record deficits. And if bonds start to take a beating in coming months, stocks could be the logical beneficiary—at least until short-term yields start to become more attractive.

By historical standards, at just 13 months of age, this bull market is still quite young. And not one bull market in over 60 years has made it to its first birthday without achieving its second.

Unfortunately, four of the past five bull markets have lasted five years or longer, which has distorted investor expectations. The average bull market duration of the past 80 years is just 45 months or 3.8 years, and with the sizable gains already under this bull market’s belt, we have serious doubts it will become “average” before succumbing. The lengthy noninflationary recoveries of the 1980s and 1990s are unlikely to be repeated.

The big gains of the past year are a direct result of the “oversold extremes” of the March 2009 bottom. The Relative Strength Index had reached its most oversold level in 78 years.

The good news is that all past rebounds off such extreme lows (RSI = 30) have never ended this soon. The bad news is that they typically do not lead to longer bull markets. All but one subsequent bull market lasted between 1.6 and 2.7 years. That places a probable top to the current bull at somewhere between next December and November 2011.

We’re likely to see higher volatility this year and additional corrections—even though this bull market has experienced more 5% to 10% corrections so far than [in] the first 13 months of any bull market in 20 years.

[And] don’t go looking for gains that come anywhere close to those we’ve enjoyed over the past 12 months. Only one post-World War II bull market has experienced a second year gain in excess of 20% (and that bull market had the mildest first-year gain of the past 60 years).

The average second-year gain for the past ten bull markets has been 12.2%—a nice target to strive to achieve this year, don’t you think?

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