November 15, 2021
Quick, what’s the longest bull market in U.S. market history?
You might think it’s the S&P 500’s 401% move from March 2009 to February 2020, bookended by the 2008 to 2009 global financial crisis and the early days of the COVID-19 pandemic…
… Or the seven-year rally that started in June 1949, as the U.S. got into the groove of dominating the world, making babies, and laying the foundation of the infrastructure we’re still using today, and returned 266%…
… and don’t forget the 417% move over about nine years that started in October 1990, coinciding with the (first) tech boom…
(A quick definition check: A bull market is when an index rises a minimum of 20% from its recent lows, and lasts until the index falls at least 20% from its previous highs – which is when a bear market kicks in… until there’s another 20% rise.)
But you’d be wrong.
The Real Longest Bull Market
Depending on who’s doing the measuring, those are in the top five bull markets (No. 1 is the bull market that ended last February)… for the U.S. stock market.
But the longest bull market ever? That’s in U.S. government bonds.
Of course, to many everyday investors, bonds are only background noise between stock market updates, just gibberish about yields rising by a few hundredths of a percent and supposedly it’s a big deal… and oh, did you see that Tesla was up another 5% yesterday, and that crypto that doubled since breakfast?
Never mind that the global bond market is around one-third larger than the combined market capitalization of every stock market on Earth. Bonds are the quiet bully, the puppet master, the market’s power behind the throne – like Louis XIII’s Cardinal Richelieu or incapacitated President Woodrow Wilson’s first lady Edith Wilson of markets.
The bond market is what Bill Clinton-era political strategist James Carville famously said he’d want to be reincarnated as – rather than as the Pope or president or a baseball slugger – because it “can intimidate everybody.”
And while you were glued to the CNBC share price ticker chyron, U.S. government bonds have been on a 40-year tear since September 1981.
That’s more than three times as long as even the most generous definition of the longest stock bull market… or 10 U.S. presidential election terms… it’s 54% of the projected life expectancy of babies born that year… and eight times the warranty period offered by Chrysler on its revolutionary-for-1981 K-car.
The epic U.S. government bond rally started around when President Ronald Reagan appointed Sandra Day O’Connor to the U.S. Supreme Court, Simon and Garfunkel reunited to play in Central Park, and John McEnroe won his third U.S. Open men’s tennis title – and, more to the point, on the last day of September 1981, when the 10-year Treasury note hit a record yield of 15.82%.
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These Are Bonds (Briefly)
Here’s what that means…
When a government (or company) issues a bond, it’s saying: “Hey, lend us some money (say, $100… this is called “par”), and we’ll pay you interest along the way” – in this case, 15.82% every year (or, in our example, $15.82… this is called the “coupon,” and it doesn’t change during the lifetime of the bond).
The bond issuer promises to pay the whole sum (that is, $100) back at the end of the term of the bond – say, 10 years, or 20 years. And in the meantime, if you decide to sell your little part of that loan to someone else, that’s fine.
(In contrast… when a company issues shares, it’s saying: “Here, take this little slice of our company, give us cash in return, and if we feel like it, we may pay you a dividend… And if you feel like selling that little slice of our company – shares – to someone else, knock yourself out.”)
But as interest rates fall, bond prices rise. That’s because the value ascribed to that rock-solid $15.82 annual cash flow is much greater if interest rates decline.
Back in September 1981, putting your cash in a savings account would make you around 16.6%. But over the following decade, interest rates collapsed, as inflation came down and the American macroeconomic house was put in order by Ronald Reagan and friends… And in 1991, you’d be lucky to make 2% by parking your cash at the friendly neighborhood lender, or in a government bond.
What that means is that as yields fell, the price of our September 1981 bond rose. Annual income of $15.82 is a lot more valuable when interest rates are 2% than when interest rates are 16%-plus.
And over the past 40 years, U.S. interest rates have been steadily declining, to a pandemic low of around 0.5%. Although there has been volatility along the way, investors with a long-term outlook have seen a big payoff on this mostly one-way bet on bonds, as prices have steadily risen as interest rates have declined.
Risk-free Bonds Versus the S&P 500
Since September 1981, the 10-year Treasury has returned 1,018% (that’s 6.2% per year compounded) through this month. The math and methodology gets a little sticky, since (for starters) a 10-year bond is around for only a decade… So computing a 40-year return involves assuming reinvestment, blending average daily yields, and other bond-math gymnastics that the curious reader can learn more about here.
That might seem like a big return. But it pales in comparison with the 3,722% return (that’s 9.5% per year), including dividend reinvestment, of the S&P 500 over the same period. Remember, though, that Treasuries generated that return without ever dropping more than 20%, while the S&P 500 had four bear markets during that period… including one when it fell 49% (March 2000 to October 2002), and another one when it lost 57% (October 2007 to March 2013).
U.S. government bonds are the global economy’s “risk-free” benchmark. The central assumption of markets is that the United States will always be able to repay its loans, and lending to the U.S. government – by buying its bonds – is the safest investment. So the yield that investors require of Uncle Sam when they’re lending him money is the foundation of all other interest rates for everything else (including stocks… more on that below).
And what about inflation? From 1981 through today, the value of the U.S. dollar has declined by about two-thirds… Today, it would take around $300 to have the same purchasing power as $100 in September 1981.
And, while we’re talking about what-ifs, how about gold? The shiny metal returned 356% over the past 40 years – around one-third of Treasuries, and one-tenth the S&P 500.
Speaking of Inflation: It’s Here
But that incredible rally may be coming to an end, due in part to the dreaded kryptonite for markets and the economy… inflation. (Though this shouldn’t be a shock, as the bond market itself told us back in March that inflation was coming.)
Following months of ever-higher readings, last week’s inflation data showed that the Consumer Price Index (“CPI”) rose at an annualized rate of 6.2% in October. (In 2020, inflation was just 1.2%… And for the decade starting in 2010, it averaged 1.8% per year.)
That was the highest rate of inflation since November 1990… when George H.W. Bush was president, people talked to each other over landlines, and the Nasdaq Composite Index ended the month at 359.10. (Last week, it closed at 15,886.)
Inflation has been fueled by a perfect storm of kinks in the global supply chain that have constrained the supply of goods… higher labor costs due to not enough workers and “treat yourself” post-pandemic demand bolstered by COVID-19 stimulus.
How to Fight Inflation
When faced with rising inflation, any central banker worth his ascot immediately twitches in the direction of the big red lever of interest rates, the bazooka of monetary policy. Interest rates in the United States have been at 0% to 0.25% since last March, and haven’t been raised since December 2018.
(Strictly speaking, the Fed changes the federal-funds rate, which is the interest rate at which banks borrow from and lend to each other… But generally when the Fed changes the federal-funds rate, interest rates charged by banks to end borrowers shift by a similar amount.)
Higher interest rates would help lead to slower economic growth (by making borrowing more expensive). This would result in less upward pressure on prices, thereby easing inflation. And at least as importantly, higher interest rates lead to higher yields – and lower bond prices (since bond prices and yields move inversely).
U.S. Federal Reserve Chairman Jerome Powell has nodded in the direction of the Fed’s interest rate lever. But the breadcrumbs that he and other senior Fed officials have dropped via carefully phrased public statements as a way of hinting their intentions with interest rates – no one, especially markets, likes surprises – suggest that the first interest rate hike won’t happen until well into 2022.
In the meantime, though, Powell said earlier this month that the Fed would begin to slowly unwind its $120-billion-per-month purchases of Treasury bonds and mortgage bond securities. This program – which has been a backdoor way of providing liquidity to the U.S. economy – has been a centerpiece of the Fed’s COVID-19 economic stimulus effort.
And even if it feels like the pandemic in the U.S. is mostly over, to the Fed it’s not. Powell announced that the Fed would reduce its monthly bond purchases by $15 billion. That was viewed as good news, because it’s a slow rollback that’s less than the $30 billion that markets had feared. And the Fed will continue to buy bonds until July.
If you think that the bond market doesn’t have anything to do with you, you’re wrong… Click here to check out the conclusion to Kim’s “Economic Kryptonite” story, including exactly how the end of the bond rally will affect you…
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Executive Editor, American Consequences
With Editorial Staff
November 15, 2021