“Someone once told me time is a flat circle. Everything we’ve ever done or will do, we’re gonna do over and over and over again.”
– Detective Rustin Cohle, True Detective
That’s the best show of 2014’s writer / creator Nic Pizzolatto borrowing an idea from Nietzsche – specifically the concept of Eternal Return. To hear Nietzsche tell it, we are either blessed or cursed in the event that time is indeed a flat circle and everything we’d already done we’d end up doing again…
The greatest weight. What, if some day or night a demon were to steal after you into your loneliest loneliness and say to you: “This life as you now live it and have lived it, you will have to live once more and innumerable times more; and there will be nothing new in it, but every pain and every joy and every thought and sigh and everything unutterably small or great in your life will have to return to you, all in the same succession and sequence — even this spider and this moonlight between the trees, and even this moment and I myself. The eternal hourglass of existence is turned upside down again and again, and you with it, speck of dust!” Would you not throw yourself down and gnash your teeth and curse the demon who spoke thus? Or have you once experienced a tremendous moment when you would have answered him: “You are a god and never have I heard anything more divine”? If this thought gained possession of you, it would change you as you are, or perhaps crush you.
Okay, enough philosophical bullsh*t for today. But I wanted to set the stage for the idea that we could be returning to the same sort of mid-cycle stock market pause we’ve seen before – with all the same sort of pushing-and-pulling, confusion and fear, that characterized those previous moments.
The great irony of the current market moment is that, while everyone screams either “Bubble!” or “Crash!”, so far we have neither. The S&P 500 has spent most of 2014 within a plus- or minus-two percent range, although some select areas of the broader markets have been much more volatile.
In my view, Mr. Market is giving us exactly what we deserve – a flat market being the most frustrating scenario imaginable. No one was positioned for nothing! Bernard Baruch famously quipped that “the stock market exists to fool the most amount of people for the longest period of time.” This year, it’s surely getting the job done.
After all, it wasn’t until the last three months of 2013 that investors’ capital truly came flying into equity mutual funds. The fact that virtually every net dollar of inbound assets hit a Vanguard passive index fund should be lost on no one. The willfully blind shoveling of money into plain vanilla funds that need an up-market to please their shareholders practically guaranteed a market standstill. Long the US indices became the crowded trade di tutti crowded trades by December. Stocks have done nothing since the apex of that rush to “buy the market,” and this is, paradoxically, just as it should be.
As to the reasons for our newly aimless market, I’ll list the most popular theories below and simply opine that the truth probably encompasses some elements of all of them (plus some secret ingredients that haven’t yet made themselves well-known to the commentariat)…
1. Digesting huge gains (duh).
2. Interest rate concerns stopped multiple expansion in its tracks (hard to understand how we push from 18 to 19 times earnings if the Fed is becoming less accommodating).
3, Institutions reallocating / rotating out of last year’s leaders (theoretically this happens every year, didn’t matter last year).
4. Earnings growth is flat for Q1, profit margins have hit a wall (this one’s pretty legit, I think).
5. Quietly rising commodity prices – oil, gas, agricultural, etc – spooking the old timers (sneak into the office of a PM who’d traded through the 70’s and 80’s and whisper ‘inflation!’, guy will jump out of his f***ing chair).
6. New Fed regime policy uncertainty (I’d buy this one too, Janet’s an unknown quantity and that weighs on hearts and minds for sure).
7. Weather-related economic uncertainty (duh, part II).
8. Housing market backsliding, mortgage rates rising while private equity pulls back (housing is super-important to the real economy and the stock market, the bull case is falling apart).
9. Too much IPO supply swamped demand (see my Ducks are Quacking post for more on this crucial topic).
10. Capital gains taxes caused forced selling in stocks with monstrous prior-year gains (a la March of 2000, I see this in my own practice btw).
11. Ukraine (Sorry, not saying it’s not potentially a big deal, but only the media seems to care. I haven’t heard a soul on Wall Street admit to having made a sale because of Russia).
The eleven forces above – in combination – could most certainly see us returning once again to markets like 1994 or 2005 and finishing 2014 flat (with max frustration for many players). Both ’94 and ’05 occurred in the midst of multi-year rallies and represented a pause in the action due to interest rate concerns and the digestion of massive gains. In the case of ’94, earnings actually grew 20 percent that year but a surprise rate hike compressed multiples on the S&P leading to a year of nothing for the equity markets. In the case of 2005, corporate profits had simply run out of room for advance – as Michael Santoli explained this week:
The corporate-profit recovery was quite mature by 2005, with S&P 500 company earnings having more than doubled from a few years earlier and average profit margins sitting near a then-record high. This presented a perceived headwind to further earnings growth and a lack of obvious fundamental catalysts for market gains, given that overall price-to-earnings multiples showed stocks were far from cheap.
The good news is that neither of these go-nowhere years presaged an imminent crash in the following year. In addition, there were several areas in the market that continued to work for investors.
Of course, there is the chance that this flattening period is a top being formed – the longer our forward progress is stalled, the less enthusiasm there will be for the push to new highs. Unlike bottoms, which are usually V-shaped “events”, the formation of tops is usually a process – bull markets usually flatten out slowly before rolling over. As old Detective Rust Cohle explains, “Death created time to grow the things that it would kill.”
I had my firm’s director of research Michael Batnick take a look at all the years in which the S&P 500 was flat (up or down less than 5 percent). It turns out that this has only occurred eleven times since 1956. Of those eleven years of flattish market performance, the average move (up or down) during the following year was a wild and wooly 18 percent. Only twice was the following year negative (1957 and 2008), on nine occasions the flat market was merely a speed bump on the way toward higher prices.
So let’s say we’re indeed heading nowhere this year, as marginally improving economic news bumps up against slightly fading sentiment to produce a draw…is that such a bad outcome? If I told you at the beginning of 2012 that the mean return for US stocks over the next three years would be 14 percent, you’d have jumped for joy! Should markets meander through the rest of 2014 as they’ve done so far, that is exactly what we’d be looking at – still one of the best three-year rolling periods in recent memory.
And need I remind you that the current “frustration” is occurring within a few percentage points of all-time record highs? Could be worse, no?
If Friedrich Nietzsche’s Greatest Weight proposition has us returning to ’94 or ’05 to mark time for a few more quarters, is that really so terrible? I suppose it’s mostly frustrating for amateur market timers, newbie indexers who plowed in at the top, traders with huge directional bets on and, of course, the financial media.
For everyone else, taking the flat market in stride shouldn’t be too difficult to do, for as long as it might persist.