The longest bull market in American history ended quickly. And it was caused by a coronavirus that has shaken the globe, as the reality sinks in that normal life will be on hold for some period of time to avoid an even greater health catastrophe.
Before we attempt to answer pressing questions about 2020 and beyond, let's start with the end of the financial crisis.
That was in 2008, just before the Great Recession ended in mid 2009. In the first few years of the 2000's, the Federal Reserve had kept interest rates too low for too long in hindsight. Loose lending from banks enabled unqualified home buyers to own property that they ultimately could not afford. The market for the mortgage bonds, packaged into complex collateralized debt obligations was large and profitable. Banks and other investors took on leveraged risk, sometimes to the tune of $30 to $1 in terms of borrowed funds against mortgage securities.
When the home owners began defaulting, the financial system collapsed. Banks needed bailout money from the Federal government. Some closed for good. Insurance companies faced massive payouts.
You know the story.
But when the economy recovered, aided by President Obama's stimulus package, growth was anemic. Investors were grappling with the possibility -- which now seems commonly accepted -- that economic growth is to be slow and interest rates are to remain low. Without those easy financial conditions -- even though banks capital standards had to be raised in order to protect against another meltdown -- there may be no growth.
In early March 2009, the 11-year bull began.
Interest rates had fallen to 2.7% by that date, down from 5.1% in 2007. Rates would fall further while central banks around the globe induced quantitative easing, programs in which central banks bought up bonds, bringing yields down and the cost of borrowing down.
Rates in the U.S. would fall steadily to 1.5% in the summer of 2016. In that time span, powered by low rates, the S&P 500 returned 179%, for a compound annual growth rate of 15%, against the long-term historical annual average of under 10%. Inflation ran at around 2% for those years. GDP growth never ran higher than 2.9%.
The market's dependence on low interest rates was characterized in July 2019 as "perverse," by E*Ttade's Head of Investment Strategy Mike Loewengart in a phone conversation with TheStreet.
The rally was characterized by, yes, low interest rates, but also with underperformance from cyclical sectors. The New York Stock Exchange Energy Index rose 32%. The Nasdaq industrials index did rise 313%, but pressured by low rates, the Nasdaq Bank Index rose just 104%.
The group of stocks that powered the bull market was one that had such strong potential growth rates that any economic cyclicality one could conceivably detect in their business models was never in the question for a market starved for growth. Those were the FAANG stocks, as coined by TheStreet's own Jim Cramer.
That's Facebook, Apple, Amazon, Netflix and Google.
Between March 2009 and July 2016, Apple, Amazon, Netflix and Google all rose 621%, 986%, 1,531% and 353%. The internet, the iPhone, e-commerce and media streaming were all in the very early innings of global adoption. Microsoft was in the midst of an impressive shift from focusing on its legacy businesses to becoming world leader in the growth market of cloud services and the stock gained 223%. The gains were just beginning for the tech giant.
In early 2017, shortly after President Trump was elected -- and some on Wall Street had encouraged his ambition to be president -- the tax cuts and jobs act was introduced. That cut corporate taxes to 21% from 35%. Individual taxes were cut as well. In 2018, GDP growth popped to 3.1%, led by consumer spending.
Corporations weren't exactly rushing into increased capital spending. The excess cash was mostly used for share buybacks and acquisitions, which saw the S&P 500 through to a yearly gain of 9% through September. Inflation spiked to 3% for a few months in 2018.
Trump's trade war with China, which reached a value of tariffs in both directions of hundreds of billions of dollars, stood no chance against the positives of the tax cut. The trade war caused volatility trough the end of 2019, but the economic data showed stable GDP at 2% and low unemployment at below 4%, as the trade war only shaved a few basis points off of GDP growth in the U.S.
The Federal Reserve raised interest rates in the fall of 2018, as Chairman Jerome Powell perceived the data to be an indication that the economy was close to running too hot.
The 10-year treasury yield rose to above 3%, unheard of for this bull market.
When a little bit of stock market selling began in October, a nasty correction began. The S&P 500, by the end of December, fell 17.5% from a then all-time high of 2,929.
The market had made itself clear, communicating that the Fed should not raise rates if the economy and the market were to continue growing.
Although 2019 saw roughly 0% earnings growth on the S&P 500, tech stocks like Apple and Facebook showed signs of growth with new growth businesses like Apple's services and Facebook's Instagram. Plus, the Fed cut rates three times. That allowed the multiple on the S&P 500 to expand to almost 19 times forward earnings estimates. And by December, the market was pricing in 2020 earnings growth expectations that were 9% at one point. The S&P 500 appreciated 27% for all of 2019.
Bulls were expecting the market to appreciate by roughly 5% on average. Multiple expansion was almost out of the cards as growth would be stable and interest rates couldn't fall much from 1.5% in January. In fact, many were looking for rates to rise a bit, which would be a boon to bank stocks and reflect the continued economic growth that could benefit industrials and consumer discretionary stocks.
But the economic cycle was aging just a few months ago. Some forecasts for GDP growth were for below 1.5%. And the stock market was trading at 19 times forward earnings, priced for perfection, according to some on Wall Street.
The Coronavirus has ended the bull market.
All three major U.S. indexes are in a bear market, with the S&P 500 down 24% from its all-time high hit just in February.
Oil companies are cutting capital expenditures by tens of percentage points -- Occidental just slashed its cap-ex budget by 32%. This means revenue contraction for industrials that supply oil companies with capital goods.
Semicondutor supply chains around the globe are inactive, as workers stay home.
The Federal Reserve has injected trillions of dollars of liquidity into the treasury market, bringing the federal funds rate down to just above 1%. Bearish investors are buying so much in the treasury market that the 10-year treasury yield of 0.94% is below the fed funds rate.
Stock valuations verses bond yields are attractive, but that's because, according to Morgan Stanley strategists, the market is pricing in a recession.
What looms ahead?
Economic data. Which the market may be dreading. And a potential political regime shift to the Democratic party. But the federal government needs to be strapped with cash, as the long-term debt cycle has taken hold. Corporate debt to GDP is currently 48%, as high as it was in 2007. This could mean catastrophe in terms of corporate credit.
The Fed wants the banking system to be prepared.
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