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What Kills Bull Markets

1/17/2018

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​The longest Bull Market in Wall street history (since the Dow’s inception in 1896, was the 1950's and in recent times,  from 1987-2000 and we are currently in the 2nd longest recession which began in March 2009 after the Dow’s low of 6,470.  At the time of this writing, the Dow is skirting the 26,000 level; an amazing increase of 402% in 9 years, an average return of 17%/year (to do this on excel, you would use the rate function under the formula tab).  It hasn’t been a constant 17% and last year alone, the Dow advanced nearly 25% compliments of Trumponomics and the new tax structure which reduced the corporate income tax rate from 35% to 21%.  What kills a bull market is quite simply a bear market.  When the Dow, or any index retreats 10% from it’s highs it’s referred to as a correction, and when it retreats 20%, it is no long a bull market and it is now a bear market.  What then, you ask, causes a bear market.  Quite simply, it is either a recession of the FED.

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        First, the FED.  The FED is often accused of taking away the punch bowl just as the party is at its wildest.   If asked, some analysts would say that the FED’s enemy number 1 is inflation.  This is technically, not the case.  Enemy number one is generally deflation since it is always indicative of a lack of aggregate demand.  This happened during the last recession between 2008-2009 when prices went down by over 2%, and the last time before that was 1950, and the time before that, the great depression.  However, it is so infrequent in recent economic history, the main issue has become inflation.  The FED steals the punch bowl (i.e., battles inflation) by raising interest rates, which makes borrowing more expensive, and reducing the money supply (by selling government bonds) which also has the effect of increasing interest rates.  An extreme example of the FED raising rates, and in this case causing a recession, was the 2nd dip of the double dip recession of the early 1980’s.  This was the worst recession since the great depression due to the fact it was extreme stagflation.  Mortgage rates soared to over 20%, which destroyed the housing market, and the unemployment rate soared to 10.8%, the highest since the depression, and remained above 10% for 8 months.  The economy was suffering from stagflation, a stagnant economy and high inflation, and the FED knew that if it battled inflation, it would send the economy into a recession.  However, they made the determination that a low inflation rate, their target is generally 2-3%, is consistent with all long term economic goals and after inflation was brought under control, the economy and the market recovered.

​   Recessions are determined by the National Bureau of Economic Research (NBER).  Contrary to what most Principles book teach, a recession is two consecutive quarters of negative GDP, this is not the case.  NBER defines a recession as “a significant decline in activity, spread across the economy, lasting more than a few months, visible in industrial production, employment, real income and wholesale-retail sales.  It is prolonged, protracted and pervasive.”  
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​A while back, one of my students asked me what causes recesiions.  The text book answer to that question is shocks to the economy; ah but there’s the rub (I’m sure Shakespeare is rolling in his grave), what causes those shocks?  My answer was 1 word, greed.  An unlike the movie Wall Street’s antagonist, Gorden Gecko, greed is not good.  If you look at the past 4 recessions, greed is the root.  The financial crisis recession was caused by the bubble bursting in the housing market, where prices in some areas were going up by 30%/year; the 2001 recession was the dot com bust, according to one analyst on CNBC, the number of dot com companies shrank from 30,000 to 5,000 and the NASDAQ dropped from 5000 to just over 1000; the 1991 recession, a mild one, was caused by the oil price shick of Iraq invading Kuwait, and the double dip recession of the 1980’s was a result of high commodity prices that plunged after the FED’s intervention.
So, you ask, how long will this bull market last?  Good luck on predicting that, but as long there is no unforeseeable shock (such as a big bomb going off somewhere), I don’t see any end to this in the next 3-6 months.  The corporate tax cut increases corporate profits by over 20%, and the reduction in regulation that Trump has accomplished by Executive Order, including the construction of the Keystone pipeline, has also saved corporate dollars.  So with the Dow rising 25% last year, it’s indicative of a fairly efficient market.  If I should see and storm clouds on the horizon, you’ll be the 1st to know.
    

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    John Tommasi is a retired Senior Lecturer of Economics & Finance from Bentley University and  the University of New Hampshire.

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