To Some Market Vets, Stocks Are Rallying Like It's 1999

The stock market has been so hot this year that it might need an ice-cold Fruitopia, or a Zima.

The furious rally that’s brought the S&P 500 to the brink of another record, so quickly on the heels of last year’s scary tumble, is reminding some market veterans of the rebound of late 1998. Then, like now, decisions by the Federal Reserve on interest rates helped send stocks soaring. Then, like now, high-flying technology stocks were leading the way. And, in both instances, investors wondered how much longer the economy could avoid a recession after many years of growth.

Few, if any, analysts on Wall Street are predicting a repeat of 1999 and 2000, when the market’s recovery ended up becoming too much of a good thing. The S&P 500 surged nearly 60 percent from its 1998 bottom and inflated into the dot-com bubble, only to burst in the dot-com bust. The collapse dashed the dreams of day traders in pajamas around the country and helped usher in the 2001 recession.

But the similarities between 1998-1999 and 20 years later are plentiful enough that some investors are pushing the idea that stocks can keep rising even with recession fears still hanging over the market.

Steve Chiavarone, equity strategist at Federated Investors, says the S&P 500 may end the year at 3,100. That would be a 6.6% rise from Tuesday’s close and a nearly 32% leap from Christmas Eve, when recession fears were at their height.

“It is unfathomable to someone at this stage, as it was in 1998, that you could have meaningful upside in the market given where we are,” Chiavarone said. “I think you have to be respectful that tops are impossible to call and that things can get ahead of themselves.”

In the summer of 1998, the S&P 500 was at a record high, and the U.S. economy was more than seven years into its expansion, one of the longest on record. But turmoil in developing economies around the world, highlighted by the Asian financial crisis and then Russia’s default on its debt, helped send the S&P 500 down nearly 20%.

The Fed calmed worries that the turbulence abroad would dash the U.S. economy by slashing interest rates three times in three months in late 1998. The S&P 500 recovered within a few months.

The action then is reminiscent of the market’s movements over the last seven months. Last winter, after setting its all-time high on Sept. 20, 2018, the S&P 500 plunged 19.8% on worries that a recession was on the way. But the Fed again helped put a floor under the stock market, this time by saying it may not raise rates at all in 2019 after seven increases the prior two years.

The S&P 500 has shot up 23.6% since hitting a bottom on Christmas Eve, echoing the 24.1% climb for the index in the same number of trading days after it hit a bottom in August 1998.

High-growth stocks are also leading the way, once again. In the late 90s, investors flocked to technology stocks because they were going to drive the “new economy.” Today, companies like Facebook, Microsoft and Netflix are alluring because they’re producing strong growth even when global economic growth is slowing and low interest rates make conservative investments more unattractive.

Technology stocks in the S&P 500 have surged 33.9% since the Christmas Eve bottom, most among the 11 sectors that make up the index.

The market has prodded a parade of tech companies to sell their stock to regular investors for the first time. Lyft had its initial public offering last month, and Uber and other big names should follow shortly.

These companies are generally more seasoned than their IPO counterparts two decades ago, with more in revenue. But most lose money, and the last time such a high percentage of companies going public were unprofitable was in 2000, when the dot-com bubble was at its height.

All this is happening while the bond market has sent signals of caution through what’s known as the yield curve. Recently, some key short-term Treasury yields were higher than for some longer-term Treasurys, which is unusual. Market watchers call the phenomenon an “inverted yield curve,” and such a scenario has preceded past recessions, although it hasn’t been a perfect predictor. In 1998, some parts of the yield curve were also inverted.

“The froth is really starting to pick up now,” said Doug Ramsey, chief investment officer at Leuthold Group. “I would never argue that this is like the euphoria you saw in the late 90s — we’re nothing close to that — but you’re still positioned just as precariously in chasing these large-cap growth stocks.”

Besides the less-exuberant nature of this rally — investors remain hesitant to put money into U.S. stock funds this year — another big difference is that stocks are not as expensive as they were in 1999, relative to their profits.

In early 1999, the S&P 500 was trading at more than 40 times its average earnings over the prior 10 years, adjusted for inflation. Now, it’s trading at a price that’s closer to 31 times. That’s still higher than its historical average of 20 times over the last half century, but not as eye-wateringly expensive.

In 1998, the economy was able to avoid recession, and the expansion that began in 1991 ended up lasting into 2001 and became the longest on record. This expansion, which began in the summer of 2009, could soon eclipse that one.

“We could very well be in a 1998 environment, where the yield curve remains inverted sporadically for a short period of time, before steepening again,” said Frances Donald, head of macroeconomic strategy at Manulife Asset Management.

She says a recession could arrive in 2020, a relatively mild one. For now, though, she says the stock market could keep rising as investors see profits still to be made.

To see why, consider the conversations she had last summer with the portfolio managers she works with, when she first began calling for a 2020 recession.

“My question was: It’s August of 2018, if I could tell you with 100 percent certainty there was going to be a recession in 2020, what would you do?” she said. Their response: “Nothing, we would trade until the market got a whiff of it.”