Mastering The Market Cycle: Getting the Odds on Your Side

by Howard Marks

First, let’s review the meteoric rise of stocks in the late 1990s and early 2000, and especially the formation of the Internet bubble. What should the alert investor have noted during that time? In the decade of the 1990s, the U.S. economy enjoyed the longest peacetime expansion in its history. In December 1996, when the S&P 500 index of equities stood at 721, Fed Chairman Alan Greenspan asked, “How do we know when irrational exuberance has unduly escalated asset values?” But he was never heard from again on this subject, even as the S&P more than doubled to a high of 1527 in 2000. In 1994, Prof. Jeremy Siegel of the Wharton School published his book Stocks for the Long Run, in which he pointed out that there had never been a long period of time in which stocks had failed to outperform bonds, cash and inflation. Whereas researchers at the University of Chicago had earlier concluded that the normal return on U.S. equities was in the vicinity of 9% per year, in the 1990s the average return on the S&P was nearly 20%. The better stocks performed, the more capital investors allocated to them. This was especially true of technology stocks, which were the clear market leaders. More tech stocks were added to equity indices like the S&P 500—meaning index and quasi-index investors had to buy more of them—which made them go up—which attracted still more capital to them. This was a classic “virtuous circle,” and no one could imagine it ending. The absence of earnings at most “new-econ...