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Fact Check: Red Flags To Watch For To Predict The End Of This Bull Market

By Investing.com (Clement Thibault/Investing.com )Market OverviewJul 22, 2019 03:39AM ET
www.investing.com/analysis/fact-check-bull-markets-200442362
Fact Check: Red Flags To Watch For To Predict The End Of This Bull Market
By Investing.com (Clement Thibault/Investing.com )   |  Jul 22, 2019 03:39AM ET
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Since the financial crisis of 2008, when the S&P 500 infamously bottomed at 666, the index has climbed around a whopping 340%, to the new all-time highs we are seeing today.

When a bull market lasts this long, it's only natural for investors to wonder if the end is near for this cycle. One way to stay alert for red flags is by looking back at past events. History often repeats itself: knowing why previous bull markets ended can help us identify potential problems ahead of time.

S&P 500
S&P 500

In previous downturns, tighter monetary policy, tighter fiscal policies, geopolitical turmoil and an overvalued stock market have been to blame. It's worth taking a look at what happened then to try to predict what may happen now.

Tighter Monetary Policies

Tighter monetary policies that brought forth recessions are truly a recurring theme when examining previous ends of bull markets. Tighter monetary conditions can limit the economy’s growth potential and cool down an economic expansion to the point of reversing it altogether.

Tighter monetary conditions preceded the end of bull markets in 1937, 1956, 1966, 1968, 1980, and 1990. In 1980, Paul Volcker, then Fed chair, raised the fed funds rate to 20%, its highest level in history, in order to reign back inflation that was running at 13% -14%. While Volcker managed to control inflation bringing it back to a "more appropriate" 7% level a year later, his action led the U.S. to a recession in 1981, and the S&P 500 fell 27% in 1980-1982. Another example is a mistimed monetary tightening that occurred in 1966 when William McChesney Martin was Fed chair. This led to a credit crunch, which in turn contributed to a 22% drop in the S&P in 1966.

Tighter Fiscal Policies

A major cause for concern during the 20th century, in the market’s earlier years, was the cutting back of government spending in 1937 and 1946. This brought forth market drops of 60% and 30%, respectively. This explanation for economic underperformance comes from Keynesian Economics, which were first popularized during the Great Depression. In Keynesian economics, government investment in infrastructure was a solution to the great depression which began in 1929. Indeed, the U.S. government slashing spending in 1937 and 1946 was a major reason for the stock market downturns that occurred in those years.

Geopolitical Turmoil and Oil Prices

While geopolitical turmoil and oil prices may not have single-handedly killed bull markets, they have played a part in stalling the markets a few times over the past decades. On three different occasions, geopolitical tensions and oil prices peaked at just the wrong moment. In 1973, OAPEC decided to issue an oil embargo. The U.S. was already treading on dangerous grounds with the abandonment of Bretton Woods (meaning dollars weren't convertible to gold as they previously were), which created rampant inflation, and a sudden 39% jump in the price of oil contributed to the end of the bull market. The same can be said about sudden oil price jumps following the 1979 oil crisis and the 1990 Iraqi invasion of Kuwait.

Overvaluations

Sometimes stock prices just rise, soaring out of touch with reality, and need to come back down. Overvaluations were the primary reasons for the end of bull markets in 1961 and 2000, and contributed in 1946 and 1987. Those four years are four of the five instances between 1946 and 2000 where the S&P 500 PE ratio was above 20 – a threshold historically considered expensive.

The dot-com bubble is perhaps the most striking example of a case where investors were swept up in the mania to buy stocks at any price. In 2000, as the internet rose to prominence, a buying frenzy led to unsustainable valuations. Companies such as the infamous Pets.com raised tens of millions of dollars only to vanish shortly thereafter when it became clear that they had no viable business model nor any path to sustainable revenue.

And while not stocks related, the housing bubble of 2007 belongs here as well. The collapse of the housing bubble triggered a nationwide financial crisis and a two-year recession, leading to a drop of 57% in the S&P between October 2007 and March 2009.

Conclusion

Back to 2019, this bull market has been running for over ten years now, and ‘when will it end’ is a very legitimate question. There’s always the possibility of a black swan type event that no one will see coming, but as interest rates seem to be on their way down, rather than up, it’s less of an immediate concern.

Fiscally, the U.S. government has consistently spent around $100 billion on infrastructure every year, and there is no reason to believe government spending will slow anytime soon. Geopolitical tensions and oil are a concern, with China, North Korea and Iran being potential conflict points.

From a valuation standpoint, the market isn’t cheap right now. The S&P 500 has a P/E ratio of 22, higher than its mean historical value of 15.75. The total market cap of the stock market to the U.S. GDP ratio is at 143%, very close to its all-time high of 148%, reached during the dot-com bubble.

So where do we go now? The market can often tolerate high valuations that may even seem unreasonable for quite some time, and geopolitically, we are still far from a war or invasion scenario. Looking at historical reasons for why bull markets end, it seems that as long as the Fed caters to the market, we’ll be fine. Once it stops though, there is definitely a risk that the relatively high valuations that we accept now will lead to more than a simple 20% correction.

Fact Check: Red Flags To Watch For To Predict The End Of This Bull Market
 
Fact Check: Red Flags To Watch For To Predict The End Of This Bull Market

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Shoaib Khan
Shoaib Khan Jul 25, 2019 9:59AM ET
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comprehensive analysis
Anonymous Red
OiledGerman Jul 24, 2019 4:28PM ET
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nice analysis
Joseph Loud
Joseph Loud Jul 23, 2019 8:13AM ET
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The ECB balance sheet is much worse than the FED , ECB " owns " through electronic ( fake - non produced administrative money ) some 50% of Europe economy . Here the downfall might be really more dramatic than a " sobering " pause . That's why Euro is falling and gold - silver are rising .
Joseph Loud
Joseph Loud Jul 23, 2019 8:09AM ET
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There is a missing factor in this very good and thorough analysis by Mr Thibault : QE or money debasement of the FED balance sheet . Since 2009 this stock market upward thrust is made possible by US Fed debasement of money through QE. From a peak of 4 , 463.542 ( 4 trillions of fake money in may 2015 ) the Fed has shrunken its electronic share of the economy to 3 815 000 ( now )= A decrease of 14% in four years  . In May 2015 the SP was at 2063 - Now it is at 3000 . From where this 50 % increase has come ? The economy make roughly 2% each year ( a 60 points increase on the SP - not a one thousand ) and the FED monetary drug is minus 14% in four years . Meaning the SP is at least 12% overvalued . A sobering pause would bring the SP at 2400 out of eventual violent exogenous shock ( Iran - China bank system - Hard Brexit )
Uri Goldshmidt
Uri Goldshmidt Jul 23, 2019 4:19AM ET
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great article
Michael Angelo
Michael Angelo Jul 22, 2019 8:18PM ET
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Fear is the ingredient to bull markets. Everybody tries to predict the fall because at this point predicting another really is obvious but, nobody saw 2008 because the normal indicators were good and normally the worst come under the radar. So, when the usual flags are obviously ok the rest is just luck and greed. Take one and don't sell articles that are just obvious.
XEVEN st
XEVEN st Jul 22, 2019 7:24PM ET
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Once you see the logical and detailed reports of why the market should fall, BUY!
Martin the Great
Conqueror Jul 22, 2019 1:00PM ET
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Very good article. But as Ben Graham used to say, when you think the market is just too high, it can make another 10-20%.
Matt luck
Matt luck Jul 22, 2019 1:00PM ET
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Benjamin Graham also said the defensive investor doesn't buy p/e over 15 heheh
Martin the Great
Conqueror Jul 22, 2019 1:00PM ET
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It depends on what kind of investor you are. Not everybody is defensive. Markets run on emotions and history proves that even if the markets seemed overvalued the price could still soar. Comparing investing method and common fact isn't relevant
Andy Laund
Andy Laund Jul 22, 2019 12:58PM ET
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thank you
Cameron Myers
Cameron Myers Jul 22, 2019 12:57PM ET
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Thank you for sharing! Excellent historical summary.
Mankirat Singh
Mankirat Singh Jul 22, 2019 11:46AM ET
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time to start short selling?
jitmeng Tan
jitmeng Tan Jul 22, 2019 10:56AM ET
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Well summarised n thsnkd
Jaime Chung
Jaime Chung Jul 22, 2019 10:34AM ET
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Nice to know
Firdaus Azmi
Firdaus Azmi Jul 22, 2019 10:21AM ET
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thanks for the information
Elephan Mann
Elephan Mann Jul 22, 2019 10:17AM ET
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Great article!
samuel nwbans
samuel nwbans Jul 22, 2019 10:04AM ET
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the bear market is coming in guess
Alex Ndala
Alex Ndala Jul 22, 2019 9:55AM ET
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Very informative, thank you.
 
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