The Dividend Pirate

The plunge in the markets this year has been pretty bad for investors globally. Add to that the credit crunch, inflation and oil prices have been rubbing salt on investor’s wounds. The S&P 500 Index has returned a negative 13.5 % return this year. Feels bad right? Consider that the bear market that ended in 1947 and 1932 each took away 17 years of investment returns. So it might get worse before it gets better. Or maybe things might get better this October.  It is interesting to note that six of the last eight bear markets ended in October.Will the pinch ever end? If yes, when will it end? How do we smell the bottom of the market? To answer these questions I was researching articles on how long do historically bear markets last. Below I am including excerpts from a great article by Dr. Bryan Taylor on Bull and Bear Markets, Past and Present written in 2002. It makes for interesting reading.

Before starting the article, I want to start with the last sentence of the article. “Histories should remind us that bear markets do end, that bull markets are stronger and last longer than bear markets, and that in the long run, the overall rise in stocks far offsets the declines.”

If you don’t have time to read the entire article, below are the highlights,

• The average bear market showed a decrease of 32.7% and lasted 1 year and 2 months.
• Since the reopening of the stock market in 1914, the average bull market showed an increase of 189% and lasted about 3 years and 7 months.
• The longest bull market occurred between May 1947 and July 1957, over 10 years!
• The shortest bull market occurred between June 1932 and September 1932.  In only three months, the market more than doubled in price.
• The 1920s bull market was the strongest, increasing by 657%, while the 1947-1957 bull market increased by 517%.
• With the exception of the 1929 market top, each succeeding bull market has yielded investors more money than they held at the previous market top.
• Although this would make the current bear market bad, the bear market of 2000-2003 gave up five years of investment returns, while the bear markets that ended in 1947 and in 1932 each took away 17 years of investment returns.
  

Bull and Bear Markets, Past and Present

Dr. Bryan Taylor, President

Global Financial Data, Inc.

When do bull and bear markets begin and end? What index should be used to measure changes in the market?  Should we use a price index or a total return index?

There is general consensus on the first two questions.  Bull and bear markets are determined by looking at the change between the highest close and the lowest close in the stock market cycle.  Typically, a bear market occurs when the market declines by 15% or more.  Historically, bull markets have had increases of 50% or more.

The S&P 500 Composite is usually used to determine the dimensions of bull and bear markets.  The Wilshire 5000 is the most comprehensive index of US stocks, but its history only goes back to 1970.  The Dow Jones Industrials Average has the longest daily history of all indices, but the Dow Jones Industrials only includes 30 stocks, and it represents only 25% of the market’s capitalization.  On the other hand, the S&P Composite includes 75% of the market’s capitalization.  It has daily data back to 1929, and monthly data back to 1871.

The third question is more controversial.  Analysis of bull and bear markets in the past has always used the S&P Composite Price Index, not the Total Return Index.  Since most investors have their money in mutual funds that reinvest their dividends, using a price index to determine the movement of markets does not reflect the results that investors receive.  Over time, price indices produce dramatically different results from return indices.

For example, the 1920s bull market topped out on September 7, 1929.  If someone had invested their money in the stock market on September 7, 1929, how long would they have had to wait to get their money back?  If you use the price index, the answer would be September 1954, but on a total return basis, an investor would have broken even in April 1945-nine years earlier!  Similarly, the S&P Composite Price Index in April 1942 was still below its level in June 1901, even though on a total return basis someone who had invested in the market in June 1901 would have gotten a seven-fold return between 1901 and 1942. As you can see, to accurately analyze market history, we must include dividends, but surprisingly, no one has done this in the past.

Daily data for the S&P Composite Total Return Index exists back to 1988, and monthly data exists before then.  Using historical data on the S&P Price Index and its dividend yield, as well as information from the New York Times Composite and the Dow Jones Industrials Average, we have recalculated historical bull and bear markets on a total return basis back to World War I.  This produces some interesting differences from the results that price indices provide.

First, using total returns reduces the size of the declines during bear markets and increases the returns to stocks during bull markets.  In fact, using total returns eliminates the December 1976-March 1978 bear market because the decline using the Total Return index was only 14.4% while the decline in the price index was 19.1%.  On a total return basis, the bull market of the 1920s registered a 657% increase as opposed to a 409% increase on a price basis, a large difference that results from including dividends.

Second, using total returns changes the timing of the bull market tops and the bear market bottoms. The reason for this is that bull markets build tops, and bear markets form bottoms.  During these time periods, investors receive dividends that increase their returns.

The overall impact is to shorten the length of bear markets and increase the length and size of bull markets.  This difference can be seen in the bear market that followed World War II.  The bear market began on May 29, 1946, hit a bottom in May 1947, then bounced up and down for two years, hitting a slightly lower low on May 13, 1949 before beginning a dramatic 7-year bull market.  However, on a total return basis, the market bottomed out on May 17, 1947, two years before the price index did.

What do we find out from this history of bull and bear markets based upon total returns?  Since the reopening of the stock market in 1914, the average bull market showed an increase of 189% and lasted about 3 years and 7 months.  The longest bull market occurred between May 1947 and July 1957, over 10 years!  The shortest bull market occurred between June 1932 and September 1932.  In only three months, the market more than doubled in price. The 1920s bull market was the strongest, increasing by 657%, while the 1947-1957 bull market increased by 517%. Also note that with the exception of the 1929 market top, each succeeding bull market has yielded investors more money than they held at the previous market top.

The average bear market showed a decrease of 32.7% and lasted 1 year and 2 months. .  The shortest bear market was the crash in 1987, which lasted less than two months. The longest bear market occurred between November 1938 and April 1942.  The mildest bear markets occurred in 1957, 1966, 1990 and 1998 when the market declined by about 19%.  The worst bear market of the Twentieth Century, the Ursa Major, was the 1929-1932 crash in which stocks fell 83.8%.  It is also interesting to note that six of the last eight bear markets ended in October.

To put the current bear market in perspective, only two bear markets have lasted longer than this one, the 1929-1932 and 1938-1942 bear markets, and only two bear markets have shown sharper declines, the 1929-1932 and 1937-1938 bear markets. Although this would make the current bear market one of the three worst of the past century, by another measure, it is not as bad as it seems. So far this bear market has only given up five years of investment returns, while the bear markets that ended in 1947 and in 1932 each took away 17 years of investment returns.

The extent of the decline in stocks has been similar throughout the world.  The Morgan Stanley Capital International World Index, the MSCI EAFE Index (which includes most developed countries except for the United States) and the MSCI Europe Index have all declined by over 50% from their peak in 2000, exceeding the declines that these indices registered during the 1973-1974 bear market.

The decline in the stock market has had a dramatic impact on the equity risk premium-the difference between the yield on stocks and on government bonds.  At the end of 1999, the 10-year equity risk premium in the United States was 9.4%, meaning that someone who owned stocks had earned on average 9.4% more in stocks than in bonds per annum during the previous 10 years.

The last time the equity premium had been over 9% in the United States had been in 1967.  However, times when the equity premium is high are also bad times to invest.  Someone who had invested their money in stocks at the end of 1967 would have made less money in stocks than in bonds between 1967 and 1977.

On the other hand, the equity risk premium now is only 1% for the ten years through July 2002.  The last two times when the equity risk premium fell below 1% was in 1982 and 1990 at the conclusion of the last two bear markets in the United States.

One of the current fears is that stocks will continue to underperform bonds in the future, as they have during the past three years.  Although we cannot determine what will happen to stocks and bonds in any individual year, history does show that anyone who invested their money in 1982 or in 1990 when the equity premium last fell below 1% would have earned more in stocks than in bonds over the course of the next ten years. Stocks beat bonds by 3.4% between 1982 and 1992, and by 7.8% between 1990 and 2000.

Below, we provide the history of bull and bear markets in the United States since 1914 on both a total return and on a price basis in order that you can compare the results. These histories should remind us that bear markets do end, that bull markets are stronger and last longer than bear markets, and that in the long run, the overall rise in stocks far offsets the declines.

S&P Composite Return Index Bull and Bear Markets 1914-2002

 S&P Composite Price Index Bull and Bear Markets 1914-2002

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