Stocks Are Moving into Thinner Air

07/12/2007 12:00 am EST

Focus:

Keith Fitz-Gerald

Editor, High Velocity Profits and Total Wealth

Keith Fitz-Gerald, editor of the Skeptical Investor, says stocks have already racked up big gains during the current four-year-old bull market, and the market may find it hard to move much higher.

If you examine each bull- and bear-market cycle over the last 136 years, you’ll notice two things: First, the market tends to move in very clearly defined cycles every 17–21 years. Second, the markets tend to define high- and low-risk times to invest all by themselves.

Let’s tackle the cycles first. The data suggest that an average bull market lasts 3.5 years with the longest on record lasting nearly ten years (beginning in 1990). Most are far shorter, with a two-year growth spurt. If we are indeed in the midst of a soft landing or record growth right now, as some believe we are, this suggests that we could stretch out the current recovery for as much as another four, even five years.

In my eyes, this is dependent on three things: the Fed staving off both inflation and deflation, a stronger dollar and continued Chinese growth supported by a US consumer who must not get spooked for any reason. All are distinctly plausible and possible—but not likely with all that’s happening around the world.

Since 1871, the average Standard & Poor’s 500 gain from bear-market trough to bull-market peak is around 125%, give or take a few percentage points. The biggest gain from bottom to top is over 400%, and as you might expect, it also began in 1990. The current market expansion since the trough of 2002 is 97%.

Many people would look at that and say, “Gee, we have a long way to go.” However, the more prudent thought is “hmm, that means the markets could stop rising at any moment.” History has shown conclusively that the latter is far more appropriate when it comes to profits, and that’s what I [mean when I say] the markets [are] moving into increasingly thin air.

Knowing this, then, is also why I am trying to gradually increasing our allocation to dividends and income while maintaining a focus on global business. It’s an “offensive defensive” strategy, if you will. Dividends and income not only provide a measure of risk control as things get choppier and more defensive, but history shows that those companies paying dividends tend to be treated far better than those that don’t when the markets get choppier like they are now.

There’s no question that there is room for the market to continue its run upward. There’s also nothing in the immediate future to point to the rally’s imminent demise. But—and this is a big “but”—the fact that we are substantially over the averages for both length and trough-to-peak [moves] over the last 136 years suggests that we are already cheating the odds. And that is reason enough to be cautious even as we remain optimistic.

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