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Rekenthaler Report

Lessons From the Long Bull Market

What most of us missed.

Who Knew?
This has been quite the streak. Since March 2009, we've had almost nonexistent interest rates, good inflation-adjusted results from bonds, and outright terrific stock performance. If the S&P 500 remains positive at year-end, it will be the index's third-longest winning stretch since Ike was president, trailing only the bull markets of the '80s (which deserves an asterisk, as 1987 finished in the black but felt anything but) and the '90s.

Six years ago, few saw this coming. Where we collectively erred:

Don't Fight the Fed
This seems obvious. And indeed, it was obvious. After all, don't fight the Fed has been a slogan for several decades now. With short-term interest rates pushed down near zero after the 2008 market crash, forcing cash yields to follow, investors were pushed toward risky assets. As usual, they obeyed the investment math.

Not many fund managers reaped what in hindsight appears to have been the easy money. One problem was a lack of cash. While active funds in theory can beat indexers by raising cash during downturns, then shopping when the bargains appear, in practice they rarely accomplish the feat. The timing is just too difficult. Also, most managers believed that while the Fed normally works asset-class miracles, this time was different. Which leads to the next point …

It's Hard to Make Money With Macroeconomics
The worriers got a big item right. The paradigm of the New Normal, initially espoused by PIMCO's Bill Gross and then widely adopted by professional investment management, argued that the great debt overhang, accumulated by consumers, businesses, and governments alike, would slow worldwide economic growth for many years to come. It did. The process of deleveraging hampered growth according to the prediction, across the developed countries. Their economic recoveries have been anything but booming Vs.

The problem was, while the worriers correctly foresaw the drag of deleveraging, they missed two critical factors that have supported stock prices.

One, inflation has remained nearly dormant. Gross called for inflation "ticking up in three to five years" in his 2009 prognostication. Had that been correct, stocks would have been punished. But it was not, and they were not. Second, the New Normal missed the tightfisted control that corporations would exert over their labor costs, which enabled profit margins to balloon. GDP growth might not have occurred, and everyday workers might not have thrived, but corporation profits certainly did. And stock prices reward the latter.

Beware of Table Bangers
In 2008's aftermath, there was no shortage of bluster. The New Normalites were relatively restrained compared with the ultra bears, who stated forcefully, and with great confidence, that the recent debacle represented only the beginning, as the rotting foundations of the global marketplace were finally giving way. Further collapse was inevitable.

Well, perhaps. But in the interim, a great deal of money was there to be made.

Penn's Philip Tetlock, who studied the predictions of political forecasters, writes: "The better forecasters were like [Isaiah] Berlin's foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive abilities. The less-successful forecasters were like hedgehogs: They tended to have one big, beautiful idea that they loved to stretch, sometimes to the breaking point. They tended to be articulate and very persuasive as to why their idea explained everything. The media often love hedgehogs."

Yes, the media do. As do we, the investors. 

The danger is particularly great after bear markets, when fear makes an expert's show of strength even more compelling. At a time of loss and fear, instinct suggests that we cling for safety, by grasping on to the words of somebody who appears to have it all figured out. Instinct is a fool. That safety is an illusion.

No Single Indicator Suffices
My favorite market indicator is mutual fund investor sentiment. As measured by percentage of net sales/current assets, with a high positive figure indicating the categories most liked by investors, and a high negative figure indicating the categories least liked, asset flows into mutual fund categories are highly instructive. To cite one all-too-typical example, monies flooded into alternative assets after 2008. They would have of course have been much better deployed before the stock downturn, rather than afterward.

Naturally, then, I grew concerned when after suffering four consecutive years of outflows, U.S. stock funds enjoyed large inflows in 2013.

However, stocks still had the Federal Reserve on their side. Also, they were attractively priced relative to bonds. A stock market yield of 2.5% wasn't great, but it was higher than what Treasuries were then paying, and accompanied by rapidly growing earnings that promised rising dividends. Those tides were flowing against the tide of investor sentiment. So, I waffled.

Which, of course, brings us back to Tetlock's foxes and hedgehogs. One big idea, driven by one big indicator, makes for a powerful presentation. Stock market pessimists basing their advice on the Shiller CAPE Ratio have been off the mark for half a decade now--but that remains a compelling story, every time I hear it. Even stronger are the tales of demographic inevitability, which swept through the 1990s. (As I recall, the graying of America ensured that stocks would rise steadily through the aughts, then collapse circa 2010.) One very big indicator--too big for anybody to handle.

The lessons of the long bull market are, in truth, lessons for the next bear market. Although the common investment dream is to be brilliant enough to dodge the bear, for most investors the real opportunity lies instead in being positioned to catch the next bull. (How many bear markets has Warren Buffett evaded?) Six years ago, too many people listened to what might go wrong, rather than think about what could go right.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.