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4 potential killers lurk as bull market hits 5
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4 potential killers lurk as bull market hits 5

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4 potential killers lurk as bull market hits 5

NEW YORK — The bull market that got no respect, the one Wall Street pundits said from Day 1 could not last, the one born on March 9, 2009, at the bottom of the worst stock market plunge since the Great Depression, turns 5 on Sunday.

But despite posting a gain of 177% — which ranks fifth-best in history and tops the average bull market return of 165%, according to S&P Dow Jones Indices — skeptical investors are still asking the same question about the "birthday bull": Can it last?

The question, of course, is still relevant. The life expectancy of the average bull market for the Standard & Poor's 500 stock index is a tad less than four years, according to InvesTech Research newsletter. Translated into human terms, that makes the current bull 104 years old, says Pat Adams at Choice Investment Management.
Adam Jeffery | CNBC

What's more, this is only the sixth bull in the post-World War II era to celebrate its fifth birthday; only three of the previous five lived to see their sixth birthdays, S&P Capital IQ data show. And the two bulls that died ended very, very badly. One ended with the stock market crash in October 1987 known as Black Monday. The 2007-2009 bull market was followed by the financial crisis and Great Recession that led to the worst stock market downturn since the 1929 crash.

"The bull is definitely getting long in the tooth," says James Stack, editor of InvesTech Research. "One should probably assume we are in the later half, if not the later third."

The bull's fifth birthday also coincides with the S&P 500 trading at an all-time high, spurring debate on whether the market is nearing a top or fit enough to outrun the bear. Also giving market skeptics pause is the fact that "story stocks" such as electric-car maker Tesla and social-media darlings Facebook and Twitter are partying like it's 1999. Also attracting attention and increasing chatter about a frothy market is the Nasdaq composite edging closer to 5000 for the first time since it peaked near that level, then crashed in 2000.

Stocks are also riding a 29-month stretch without suffering a "correction," or a drop of 10% or more. Historically, corrections occur every 18 months, S&P Capital IQ says. If the past is a guide, that raises the specter of a potentially bigger drop when the bull finally expires, says Sam Stovall, chief equity strategist at S&P Capital IQ.

"The longer we go without resetting the dial, the greater the likelihood of a steeper correction, and the greater likelihood that it becomes a bear market," says Stovall.

But despite all the angst, it's important to point out that bull markets don't die just from old age. Just because stocks are trading in record territory and the bull has lasted longer and posted fatter gains than long-term averages, doesn't mean the bull can't keep stampeding, Wall Street experts say.

"Averages don't tell you anything," says Tom Lee, chief U.S. equity strategist at JPMorgan Chase.

The 1990s bull market was both the longest (it lasted 9½ years) and the most profitable (it posted gains of 417%).

When looking at future outcomes in the stock market, the key question is whether conditions are ripe for economic growth and corporate earnings to rise quickly. Using that "formula," Lee says the current bull, which has been driven by Federal Reserve stimulus, a healing economy and record-profitability from Corporate America, will not only reach its sixth birthday in March 2015, but will likely chug on until at least 2017. Drivers include a rebound in infrastructure spending, households with lower debt loads and cash to spend, and massive wealth gains from the stock rally, Lee says.

"The big headline," says a bullish Charlie Bobrinskoy, director of research at Ariel Investments, "is that people make the mistake of saying the S&P 500 is at a record high, so therefore, it must be overpriced. The market is designed to make new highs."

"Age alone," adds Stovall, "doesn't kill a bull."

So if old age doesn't kill a graying bull, what does?

"Bear markets normally require a trigger," says Stack, adding that despite rising risks he would "still put odds" on the bull continuing.

What are the warning signs? Are they present now?

Here are four potential bull killers:

1. Recessions. "Most bear markets are caused by recessions," says David Bianco, chief U.S. equity strategist at Deutsche Bank.

The reason: When the economy contracts, so do corporate earnings, the lifeblood of a healthy stock market.

Investors often start selling when signs of a recession start to appear. Warning signals include slowing GDP growth, falling consumer confidence and the rolling over of leading economic indicators.

The last bear market, which lopped nearly 57% off the S&P 500, began in October 2007, two months before the start of the 18-month Great Recession. Most of Wall Street's biggest bear markets, such as the 48.2% drop in 1973-74, the 60% plunge from 1937 to 1942 and the 86.2% fall after the 1929 stock market crash, were all accompanied by recessions.

But a recession is not a great threat at the moment, says Bianco. Wall Street is expecting GDP growth, which measured 2.4% in the final quarter of 2013, to re-accelerate this year and claw its way back to its longer-term trend-line growth of 3%.

"There's a great deal of potential for a long-lasting economic expansion for the U.S. economy," says Bianco, who says there's an 85% chance the bull will reach its sixth birthday and dodge a 20% drop, or bear market. Data from Deutsche Bank show that so-so-called secular bull markets, or long-term ones that notch record highs, tend to continue for three years, on average, after new highs are hit. The S&P 500 took out its prior peak in 2007 a year ago in March.

Ariel's Bobrinskoy, who is bullish, cites the ongoing recovery in the housing and auto industries, a vibrant new energy sector in the U.S., and a recovering Europe as "four big tailwinds" that will propel the economy.

2. Hostile monetary policy and inflation. Fed interest rate increases are often bull killers. Higher rates tend to slow growth, reduce risk-taking and cool hot markets. Inflation reduces consumer buying power, which hurts sales of goods and services and crimps corporate earnings.

Stocks suffered a 27.1% drop from November 1980 through August 1982, in large part because then-Fed chairman Paul Volcker, in an effort to snuff out double-digit inflation, raised a key short-term U.S. interest rate from roughly 11% in 1979 to a peak of 20% by mid-1981.

While the Fed has said it would hold off on raising short-term rates until sometime next year, when they expect the economy and job market to be on solid footing, there's risk of a Fed-induced sell-off, says Todd Schoenberger, managing partner at LandColt Capital.

The unwinding of the Fed's unprecedented and experimental bond-buying program, dubbed QE, could roil markets and cause a market drop of 20% or more, he says.

"It's difficult to predict what will happen as a result of tapering," says Schoenberger. "No one knows what it means for stocks or the economy. I don't see the supporting evidence to suggest the economy can support itself without help from the Fed. With less stimulus, earnings and the economy are unlikely to be strong enough to justify current prices."

3. Excessive valuation. Stock markets that sport sky-high price-to-earnings ratios are also vulnerable to a big drop. A prime example was the bear market following the dot-com tech stock bust in 2000, when stocks got wildly overvalued relative to business fundamentals.

The P-E ratio of the S&P 500 ballooned to 28.2 at the end of 1999, according to Thomson Reuters. Near the 2007 top, the market was trading at more than 17 times its past 12-month earnings. Currently, the market's P-E is 16.9.

The market is not widely overvalued by any measure.

"Valuations," says Stack, "are not excessive. And the greater the excess, the greater the downside risk."

4. Exogenous shocks. It's hard to predict the unpredictable. Think "Black Swan" events such as the fall of Lehman Bros. in 2008. Or the stock market crash in October 1987. Or the latest scare from saber rattling caused by the crisis in Ukraine. Or the bursting of a real estate bubble in China.

These are triggers that can end bull markets.

Regardless of what plays out on Wall Street in the next year, investors need to brace themselves for change, confusion, volatility and the occasional market pullback, says Woody Dorsey, founder of Market Semiotics.

"The market is going to be more complex this year," he says. "Chances are it will be a far different year than last year. This is likely to be a market that the average won't understand."

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