Two Years After Hitting Bottom, Will Markets Rally or Reverse?

If investors thought things were bad two years ago when the Dow Jones Industrial Average and the S&P 500 hit 10-year lows during the depths of the economic crisis, they're probably not much happier today. While the good news is that stock prices have recovered -- gaining 85% since the financial markets hit bottom on March 9, 2009 -- the bad news is there's just as much uncertainty in the market as there was then, and investors are fearful that at any moment, something could trigger another massive crash.

The truth is, there is a case to be made for either a major bear market pullback or a major bull market run on top of the two-year rally we've already experienced. While there are certainly a multitude of things for investors to worry about, are a number of things have improved over the last two years.

Companies are in Better Shape Than Two Years Ago

The economy is in better shape than it was two years ago, and the prevailing opinion on Wall Street is that most companies are in better shape too, having engaged in massive layoffs and cost-cutting measures to maintain their profit margins during the recession. But now there are few easy ways left for companies to cost-cut their way to more profits, and they're faced with having to generate higher sales revenues in a vastly different and more expensive environment than existed two years ago.

Making matters worse, the costs for commodities and raw materials have doubled or tripled over the last two years. Those higher prices for oil, corn, cotton, soybeans, metals and energy are cutting into profit margins, and many firms will have to substantially improve their sales just to keep pace with last year's profit levels.

Can companies realistically expect higher sales when everything costs more, consumers are still being cautious about spending, and the economy is only expanding at a moderate pace? If they can, we're probably looking at an extended bull market. If they can't, then the bears will likely creep back into the picture.

A Technical Argument for Bearishness

Since the market lows in March 2009, we've experienced a two-year bull market rally, something the analysts at Schaeffer's Investment Research say has only happened nine times since 1900. Two years of virtually uninterrupted upward market movement should be something to celebrate, but historically, that pattern has been the harbinger of a market pull-back, not a jumping off point for a prolonged rally. The last two-year bull market ended in March 1987 and it was followed seven months later by the October 1987 Black Friday market crash.

"After hitting a two-year bull market anniversary, the Dow has tended to continue its rally during the next six months," reports Rocky White, Senior Quantitative Analyst at Schaeffer's Investment Research. "However, the returns are bearish in the longer term. One year after this event, the Dow averages a loss of 2.7%. Two years later, the Dow was higher only 25% of the time averaging a significant 6.3% loss."

While such an assessment could feed investor pessimism, it should be noted that we've never experienced a two-year bull market in such a global economy. International markets will have a much bigger effect on what happens this time, so it could be argued that we are in uncharted territory.

Room for Bulls: Stocks Aren't as 'Up' as They Look

While Wednesday marks the two-year anniversary of a bull market, it also marks the end of what some consider a lost decade for stocks. The average stock market returns over the last decade were slightly negative, and analysts from Savant Capital Management say that hasn't happened in more than 100 years.

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"Historically, after a 10-year period of no returns for the S&P 500, you tend to see above-average returns for the next decade going forward," says Grant Moore, a financial adviser for Savant Capital.

Moore says that while there could certainly be a market pull-back in the short term due to fears about political upheaval in the Middle East and other factors, he predicts the average yearly returns during this coming decade are likely to be one or two percentage points higher than they would normally be. "If the market usually produces 9% to 11% gains, you can reasonably expect 10% to 12%," he says.

Why is Moore so upbeat? He believes the last market crash has left many stocks unfairly undervalued, and he doesn't see values decreasing much more because most companies have done a good job cutting costs and paring down debt.

"The fact is that companies are sitting on record levels of cash -- they are extremely profitable and undervalued relative to the long-term averages," Moore notes. "That should signal to most investors that we are going to experience some positive returns going forward."

Whether that period of gains will last for a decade or only the next six months is anyone's guess.