Why This Might Be the Start of the Next Bear Market
Probability and the Market
Best Canadian Dividend Stock Number Four
The S&P started off August with its biggest weekly loss since 2012, erasing two months' progress in just three days. While we got a small bounce yesterday, many analysts are predicting more downside from here. Some are even saying the bull market that brought us this far is over.
One frequently cited reason for this thinking is the age of the current bull market. Unless you count 2011 as an interruption, the current bull market has been advancing since March 2009, making it five years and four months old. A 2013 study by InvesTech Research found that of the 16 bull markets since 1932, only three lasted longer than five years. So in a sense this bull was already on borrowed time.
In addition, the median gain of every bull market since 1921 is 115%. So with a 164% advance in the S&P from the low in March 2009, this bull was already far past average.
Dan Sullivan, a legendary market timer and Editor of The Chartist, once wrote: "The longer a bull market lasts, the greater its chances of prevailing. It is similar to insurance companies' actuary tables in that the longer you live, the greater the odds are that your life span will be above average."
It seems like common sense when you put it that way, but many investors don't have a completely logical sense of probability. Instead, they look at a long bull market and feel like a gambler at a Roulette wheel that has just come up red five times a row. The human tendency to think the next spin is more likely than usual to land on black (it's not) is called the gambler's fallacy.
The fallacy obviously doesn't apply that well to the stock market, since the odds of the market going up on a given day are not 50-50, and are in fact quite heavily influenced by what happened the previous day (unlike a Roulette wheel). But it's still a fair analogy for what many investors feel when they look at a chart like the one above.
The Stock Trader's Almanac has done some studies that prove this "feeling" is just as misguided in investing as it is in gambling. Editor Jeffrey Hirsch wrote in 2013: "Looking back at the last 64 years of S&P 500 trading seems to confirm that just because there has not been a correction for six months, does not mean it is more or less likely to begin now. For starters, since 1950, there were five full calendar years in which there were no 5% corrections; 1954, 1958, 1964, 1993 and 1995. The longest streak was 594 calendar days from December 1957 to August 1959. This streak nearly covered an entire bull market; it came up just two months short."
The same goes for the end of bull markets-just because the end of this bull is "overdue," does not make it more likely to happen soon.
In fact, of the three bull markets since 1932 that have lasted longer than five years, none ended in the fifth year. The bull market that began in 1974 was the shortest-lived of the three, ending just after its sixth birthday, while the bull market of 1949 lived to be seven. The longest-lived was the bull market that began in 1990, which lasted for over nine years. So perhaps living past five years actually makes this bull more likely to live on!
More likely, this is one area in which probability is unlikely to help you.
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While no one can predict what the market will do next, it's still a good time to take a more cautious stance, avoid buying large new positions and possibly gravitate toward lower-risk stocks, if they're part of your investing system.
Which means it's a good time to introduce the fourth stock on my list of top Canadian Dividend Payers. To recap, I started this series in April, both in response to subscriber demand for Canadian stock ideas, and in recognition of the fact that Canadian stocks are some of the best dividend payers in the world. The idea is to find the best Canadian stocks for investors in the U.S., Canada and everywhere to buy and hold for yield and price appreciation.
The stocks have to be listed on a U.S. exchange, have good yields, good earnings trends and good IRIS ratings. (IRIS, my Individualized Retirement Income System, is the stock-picking system behind Cabot Dividend Investor, my new premium Cabot advisory.)
Today, my screens led me, once again, to a Canadian bank. (My first pick in this series, back in April, was Toronto Dominion Bank, TD up 11% to date.)
Bank of Montreal (BMO) is TD's smaller sibling, currently the fourth-largest bank in Canada. Here's a one-year chart of BMO's price:
BMO pays quarterly dividends that currently yield 3.9%. The company has increased the dividend twice in the past year, resuming a trend of strong dividend growth. (After raising the dividend every year from 1995 to 2008, BMO suspended dividend increases for a few years in response to the financial crisis. However the dividend was never cut.)
IRIS gives BMO a Dividend Safety Rating of 9.1 and a Dividend Growth Rating of 5.9, although I expect the latter to improve steadily as BMO keeps the dividend increases coming.
Operating income has steadily increased every year since 2008, and the company has kept the payout ratio below 50% for the past two years.
If the market's current pullback turns out to be a regular correction and not the start of a new bear market, it could present dividend investors with a good opportunity to establish a position in this high-quality Canadian bank at advantageous prices.
Chloe Lutts Jensen
Chief Analyst, Cabot Dividend Investor