Summary
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In 1999, Warren Buffett said that stock market returns would underperform over the next 17 years.
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Cycles indicate that the next 17 years will be a secular bull market.
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Volume data and price recovery were the keys to the change in the trend.
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Magnitude of secular trends in the past point to 10-fold gains in DJIA.
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The work of Edson Gould in 1935, 1979 and today.
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Look for average real compounded annual returns of +12% v. the historical +7% real returns.
Happy New Year! This is the first posting for 2018 and we want to be clear about what we see for the market. Dow 130,000 is not specific to 2018 but to the secular market trend that we are in. Below we have outlined our thesis with what we believe to be the supporting evidence. Regular readers of our site know that we’re not ones to promote hyperbolic tirades to buy. We routinely err on the side of caution by offering up downside risk assessments before making any upside predictions, sometimes to our own detriment. However, after reading our work, we are convinced that the uninitiated will come away well versed in how Dow 130,000 is the next market plateau.
A Quote Worth Note
To start this off in the most appropriate fashion we present to you the words of Warren Buffett from 1999:
“Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like--anything like--they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate--repeat, aggregate--would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more (Loomis, Carol. Mr. Buffett on the Stock Market. Fortune. November 22, 1999. accessed: everyday since.).”
“And if 4% is wrong, I believe that the percentage is just as likely to be less as more.”
At the time, many people have asked why Buffett suddenly got into the stock market predicting business when he has been notoriously against it in the past (market predictions falling in line with trying to timing the market). This commentary by Warren Buffett in a November 22, 1999 article from Fortune Magazine will make a lot of sense after reading this article. However, in the meantime, let’s review the 17 year performance of the S&P 500 Index in real terms from January 1, 2000 to December 31, 2016 as presented by MoneyChimp.com.
In the 17 years since Buffett’s comments, the stock market has gained +2.27% when adjusted for inflation and compounding of dividends. Even if we included the year 2017 in the picture, the CAGR of the S&P 500 would have been +3.15%. What kind of supernatural beast is Warren Buffett to make these claims and then get it right. We believe we can demonstrate exactly what Buffett is seeing when he looks at the stock market to determine expected real return. To do this, we hope to gently ease you into it before slamming you with a heavy dose of market forecasting as demonstrated by Edson Gould.
Cycles In the Stock Market
In our November 2012 article titled “Dow Theory: Secular and Cyclical Markets,” we outlined secular and cyclical trends in the stock market from 1906 to the present. In that piece, we concluded, “…this suggests that if the 2000 peak holds then the secular bear market should end in the years between 2016 to 2023.”
“This suggests that if the 2000 peak holds then the secular bear market should end in the years between 2016 to 2023.”
Offering up a timeframe of 2016 to 2023 is too general for practical use. However, our expectation would be that specific parameters would be met for us to feel confident that the bear market in stocks had ended. The first parameter would be for the market to exceed the 16-year minimum timeframe of past secular trends in the market.
To review, the secular trends are as follows:
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1906-1924: Bear Market (18 years)
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1924-1942: Period of Adjustment (18 years)
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1942-1966: Bull Market (24 years)
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1966-1982: Bear Market (16 years)
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1982-2000: Bull Market (18 years)
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2000-2016: Bear Market (17 years)
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2016-2032: Bull Market (16 years)
The Keys to the Change in Trend
What was the cause of the change from a secular bear market that began in 2000 to a secular bull market in 2016? Price recovery and volume increase.
Starting with volume data, we have long argued that since 2008, a curious trend had emerged as the stock market experienced a recovery from the lows, trading volume was actually contracting rather than expanding. In our March 13, 2013 article titled “Dow Theory: The Beginning of a Cyclical and Secular Bull Market?”, we expressed our concern of the fact that, in spite of the rise in price, the trading volume was not confirming the move higher in the stock market. In spite of our concerns on trading volume, we said, “If the current implications are correct, we could be on the cusp of a run to Dow 100,000.”
“If the current implications are correct, we could be on the cusp of a run to Dow 100,000.”
In the chart below, we see that the declining trend of trading volume in the Dow Jones Industrial Average since 2009 has finally came to an end in November 2016.
In an April 7, 2017 article titled “Market Speaking Volumes” we said, “Can the market achieve the vaunted heights of 10 times the prior low as was the case in 1942 to 1966 or 1982 to 1997? Considering that the period of the interest rate cycle corresponds to the 1942 period, we think there is a distinct possibility that “takeoff” is a possibility.”
The combination of price and volume confirming the trend in the stock market move to the upside, after a 16 year period, points to an end to the secular bear market and the beginning of a secular bull market. The engines are gunning and we’re barreling down the runway, we believe that liftoff has come. There will be turbulence along the way but the destination is known.
Ten Fold Never Grows Old
Let’s see what history has to say about the emergence of ten fold (and those that came close) moves in the stock market.
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In the period from 1903 to 1929, the Dow Jones Industrial Average increased from a low level of 42.15 to a high of 381, an increase of +804%.
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In the period from 1942 to 1966, the Dow Jones Industrial Average increased from a low level of 92.92 to a high of 995.15, an increase of +970%.
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In the period from 1982 to 2000, the Dow Jones Industrial Average increased from a low level of 1000 to a high of 11,722.98, an increase of +1,072%.
In each of the three scenarios just presented, the Dow Jones Industrial Average has easily achieved over eight hundred percent to +1,000% gains. This excludes the 1974 low to the 2000 peak which saw the Dow increase +1,942%.
“the Dow Jones Industrial Average has easily achieved over eight hundred percent to +1,000% gains.”
What’s the point of this exercise in playing with the numbers? We’re trying to demonstrate the ease with which the Dow Jones Industrial Average increased by 10 fold within the investment lifetime of an average investor. Get this, no matter your age, if you’re investing in stocks for the next 16 to 22 years, you’ve got the sweet spot ahead of you.
Edson Gould: Calculating the Future
In June 1935, Barron’s presented a contest where readers could present their forecasts for the stock market. One of the winners of the contest, a man going by the pen name of Edson Beers, offered up the following forecast:
“The well advised investor, who held the best stocks from July, 1932, into February, 1934, then shifted into bonds, should by now have shifted into second-grade stocks to hold into the fall of 1936. If the foregoing schedule works out, he should then shift to more stable investments for a period of seven months to a year, and then be prepared to shift to thoroughly speculative issues (Bull Market Prospectors Sound Cautionary Note. Barron’s. April 12, 1937. page 11."
The chart of the Dow Jones Industrial Average should be all the commentary needed about the quality of the analysis provided by Edson Gould in 1935 about the market and investment policy.
In December 1978, when the Dow Jones Industrial Average was trading at 816, Edson Gould said, “We have taken our projections of a DJIA rise from 570.01 on 12/9/74 to 3,474.80 on 1/11/90 and calculated the moves it would make if it followed the average of the patterns etched in the time and price by the bull markets of 1921-29 and of 1942-66.”
“…our projections of a DJIA rise from 570.01 on 12/9/74 to 3,474.80 on 1/11/90…”
In November 10, 1982, Gould goes on to say, “This market should last for eight years into 1990, or possibly 16 years, as did the preceding bull market, into 1998 , near the end of this century.”
“This market should last for eight years into 1990, or possibly 16 years, as did the preceding bull market, into 1998 , near the end of this century.”
The chart of the Dow Jones Industrial Average should speak volumes of “average” nature of the bull market predicted by Edson Gould.
Clearly, Edson Gould is a beast when it comes to predicting the future prospects for the market. On our website, we have used much of Gould’s work to project downside targets with a high degree of accuracy from the price of Berkshire Hathaway to Bitcoin. Now, we are excited to apply Gould’s formula for projecting upside targets based on the successful accomplishment of a what we believe to be a Dow Theory secular bull market indication. We are particularly drawn to Gould’s work because it is very conservative on the extremes both up and down.
Based on the work of Edson Gould, the Dow Jones Industrial Average is projected to attain a level of 69,832 by October 26, 2032. However, prior market history shows that secular bull markets achieve a high of 10x the breakout level. In this case, the breakout level could be considered Dow 11,722 in the year 2000 or Dow 14,164 in the year 2007. The average of the two is 12,943 which brings us a 10 fold figure of 129,430.
On Buffett and Timing
Warren Buffett is a shrewd investor who eschews timing the stock market. However, being as smart as he is, Buffett wasted no time or money in shutting down his partnership to new investors in 1967 as the Dow Jones Industrial Average was coming off of its high of 995. Why did he do this? Because “there will also be the occasional security where I am really competent to make an important qualitative judgment. This will offer our best chance for large profits. Such instances will, however, be rare.”
Warren Buffett will not time the market, however, he has lived through and invested in and out of the last two secular bull and bear markets. Key to Buffett’s success is recognizing the limits and opportunities and investing aggressively, passively or not at all. Therefore, Buffett was well aware of the established trends in the stock market when he said in late 1999 that the prospects for market performance were likely to underperform the historical average real return.
We believe that Mr. Buffett was not exaggerating when on October 16, 2008 in a New York Times article he said, “Buy American. I Am.” Now that we have what we believe to be confirmation of the change from a secular bear market to a secular bull market, investors need to act accordingly.
-The New Low Observer Team