What do you remember about 2004? Not much? Well, let’s see. Bush Jr. got re-elected. I moved to London, England. And I couldn’t tell you what the top movies, books or songs were without Googling them.

Oh yeah, Google went public in 2004. And Facebook launched that year. I just Googled that.

Anyway, the way the stock market was set up then is interestingly similar to the current market, in a positive way.

That’s according to a strategist at Morgan Stanley. Here’s why.


by Callum Keown, MarketWatch

In our call of the day, Morgan Stanley said 2021 was beginning to resemble 2004, a year that may offer clues for investors as to what will happen in the months ahead.

After the U.S. recession ended in 2001, a “deep malaise” set in until 2003, when unemployment peaked and markets finally troughed, the bank’s chief cross-asset strategist Andrew Sheets said in a note.

He noted that the rally of 2003 was “classic early-cycle stuff,” with strong performance in small-caps, cyclicals, commodities, inflation breakevens and low-rated credit.

“That rally meant that markets entered 2004 with a lot more in the price.”

There are similarities between valuations back then and those today, he said, also acknowledging how abnormal the current times are.

  • The forward price-to-earnings (P/E) ratio of global equities was 17x compared to 20x today.
  • The U.S. 10-year break-even rate was 2.30%, against 2.26% today, while the VIX volatility index was at 15 at the start of 2004, compared with 18 at the time of writing.
  • The DXY dollar index was at 87 on Jan. 1, 2004 and currently sits at 92.

Growth and inflation both moved higher in 2004 and the “market tone changed” as the economy recovered, Sheets said.

Energy, utilities, industrials and staples were the best performing sectors globally, while communication services, healthcare, materials and technology were the worst.

“In short, 2004 represents a more mid-cycle market after a strong, early-cycle rally. It saw similar valuations.” Sheets said. “And what happened next is similar to some key Morgan Stanley forecasts — a pause in equities within an ongoing bull market, lower default rates but slightly wider spreads, modest USD strength and more mixed equity leadership.”

While historical comparisons are never perfect, investors can look to 2004 for clues on how to outperform today’s market, he said.

Non U.S. stocks outperformed 17 years ago and rewarded those with a more balanced cyclical/defensive exposure, loan outperformed bonds, and selling equity volatility was preferable to taking other risk premium, he said, noting that those were strategies Morgan Stanley currently likes.

There are differences, though, for example the Federal Reserve was hiking interest rates in 2004, while the central bank has only just signaled that rate increases will come in 2023.

2004 was also an election year and central bank policy and liquidity was different, so it is a less useful comparison for global rates.

However, Sheets said early 2004 marked a midway point between the end of easing — a 25 basis point cut in June 2003 — and the start of tightening, a 25bp hike in June 2004, offering more in common with today.

Lastly, Sheets highlighted just how quickly things can change, noting that on Jan. 1, 2004 the Fed was emphasizing patience, but by June it was “embarking on hikes that would raise the target by 425bp over the next two years.”

Image source: www.hobbylark.com

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