Forty years ago this week the bull market started in the United States. Not just any bull market, but the biggest bull market ever. Despite the crash of 1987, the dotcom graveyard, the attacks of 11 September 2001, the Great Financial Crisis and the Covid pandemic, this bull market continued to rise, fuelled by structurally falling interest rates, higher valuations and sharply rising profits.
The Dow Jones bottomed forty years ago on 12 August 1982 at 777 points, the same level as in January 1964.
The Amsterdam Exchange index (AEX) only started in 1983, but the Statistics Netherlands (CBS) price index stood at 58.1 points in August 1982, a level that had also been reached in April 1961. In the meantime, there were dividends, but also inflation. Paul Volcker had defeated the inflationary spectre of the 1970s with a double-dip recession in 1982. The Federal Funds rate stood at 10 per cent, but that had been 19 per cent a year earlier and the start of a long, steady decline towards zero. The P/E ratio at that time was 7.7, slightly more expensive than the average oil company today.
Not so long before this, the usefulness of the stock market was still in doubt. At the end of the 1970s, several banks considered closing down their securities departments because there was no money to be made. The bear market of the 1970s was tough. Shares often rose in the morning and fell in the afternoon, and there were many interim rallies that always ensured that investors stepped in, only to be mercilessly punished not long afterwards. Only the pure value investors were able to survive then.
Reagan tax cuts
The bull market that started in 1982 was helped by Ronald Reagan’s tax cuts, especially the lower tax on capital gains. Together with lower interest rates, this meant that good ideas could be financed at a much lower cost. It was the beginning of Silicon Valley and the personal computer, often seen as the beginning of the IT age.
The average consumer could not do much with such a PC, but for companies working with spreadsheets, 20 hours of work could now be done in 15 minutes. Remember that this was still the time of typewriters and files were stored in long rows of paper. Ten years later, files could be sent via the Internet, the basis for cloud computing, search engines, the iPhone, Uber and finally crypto. The early 1980s was also the moment when the network effects of container transport gained critical mass, a powerful impetus for a globalisation wave.
The basis for the IT boom is microchips. The observation made by Gordon Moore of Intel in 1965 was that the number of transistors on a microchip doubled every two years. This unprecedented exponential growth provided a productivity impulse and thus a strong growth in prosperity. This growth was largely real, but IT also ensured continually lower prices. Central bankers who were still used to fighting inflation were given extra room to lower interest rates. These in itself healthy price decreases were compensated by extra debt, money that also then was the fuel for the bull market. Looking back in history now, we see that we were at the foot of the current debt mountain.
At the beginning of this year the bull market peaked and since May we have been in a bear market. This one is different from the previous bear markets during the last forty years.
Central bankers in place
Since the 1987 crash, central bankers have been in place to prop up the markets. The pain of a recession could be avoided by lowering interest rates. Investors benefited from this and soon the idea of the Greenspan pit (or the Fed pit) was born.
In every crisis since, investors have relied on central banks to intervene to support financial markets, using helicopter money if necessary. The result: more debt. That is no longer possible. If central banks were to support the market today, they would immediately lose credibility. The monetary madness of recent years has been so extreme that the value of money is rightly being questioned. That which Paul Volcker managed with great pain and effort forty years ago is now in danger of disappearing in a short time.
Many do not realise it yet, but the eurozone is well on the way to the next and possibly last euro crisis. The US dollar is doing everything in its power to squander its status as a reserve currency, including using the currency as a weapon against the Russians and thus against the Arabs and Chinese.
Next bull market
The next bull market will not have the advantage of low valuations at the start, nor the advantage of high interest rates that can fall, but it may have the advantage of innovation and productivity. For what the monetary experiment shows is that consumption and investment are not guided by interest rates. Lower interest rates mean that savers have to save more and investors use borrowed money to plunge into safe existing assets. Because interest rates, the price of money, are manipulated, entrepreneurs cannot calculate whether investment plans will make money.
A normalisation of interest rates is good news in this respect. Not only does it mean the end of the existing zombie army of loss-making companies. From now on, anyone with a good idea will get financing and will not be bothered by false competition, because without good ideas they cannot finance themselves.
Innovation pays off again and that is a very strong incentive for more innovation. But first inflation has to be brought under control and this is probably a bigger task than markets seem to be counting on now. This creates short-term price risks, but the normalisation of interest rates and valuations combined with a return to exponentially growing innovation opportunities is ultimately good news for all investors.