Is the End Near for Three-Year-Old Bull Market?

Don't trust the stock market. The rally won't last. Stocks are on a short-lived sugar high. The gains, engineered by government bailouts and super-low interest rates courtesy of the Federal Reserve , are artificial.

A tour bus passes the Wall Street bull in the financial district January 22, 2007 in New York City.
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A tour bus passes the Wall Street bull in the financial district January 22, 2007 in New York City.

That's what the skeptics on Wall Street have been saying since Day One of the current bull market, which was born on March 9, 2009, the day stocks finally stopped falling after the biggest and scariest plunge this generation of investors has ever seen.

Well, the skeptics have been wrong — so far.

The baby bull nobody believed in, the one that has earned little respect despite posting a 103 percent gain, the one that grew up in the shadow of the worst financial crisis since the Great Depression, turns three on Friday.

But despite a résumé that includes accomplishments such as being the first bull market to gain 100 percent in its first three years and the seventh-best percentage gainer of all time, this one enters its fourth year with still-skeptical investors asking the same question: Can it last?

"There are a lot of nervous investors who are still not buying into this rally," said Andrew Fitzpatrick, director of investments at Hinsdale Associates. A clear sign of the anxiety is reflected in the flow of funds into mutual funds and exchange traded funds. In this bull market as of January 2012, investors have stashed roughly $261 billion in stock funds and $708 billion in more-conservative bond funds, according to the Investment Company Institute (ICI), the mutual fund industry's trade group.

The steep fall and subsequent rebound of the stock market caught many investors by surprise. After tumbling nearly 57 percent from its October 2007 all-time high of 1565 to a low of 676 in March 2009, the Standard & Poor's 500 index has doubled in value in the past three years, climbing as high as 1,374 on March 1. The massive move erased all but 12 percent of the losses suffered in the last market downturn, the worst since the 1930s. In the same period, the Dow Jones Industrial Average fell from a peak of 14,164, to a low of 6,547 before barreling back above 13,000 last week for the first time since May 2008.

Today, investors will welcome any signs of stability. More and more, the financial well-being of Americans is tied to how their personal retirement accounts perform in an increasingly volatile market that is driven by the perceived health of the economy and the confidence level on Main Street.

Over the past 20 years, the number of U.S. households investing in stock and bond markets via mutual funds has more than doubled from 23.2 million to 52.3 million, according to the ICI. More than 90 million people — nearly a third of the U.S. population — invest in mutual funds.

So Americans have become more invested, literally and figuratively, with the ups and downs of the markets. Indeed, just as fears of a double-dip recession in the U.S. have been fading recently amid a steady, incoming batch of better economic data, and a worst-case outcome to Europe's debt crisis seems to have been taken off the table, fresh worries have emerged to give investors pause.

There is a sense that it will take some kind of shock to end the rally. Potential bull killers:

1. Gas Price Shock

Investors fear that sticker shock at the pump could create stock market and economic turmoil if tensions over Iran's nuclear intentions and capabilities lead to a military confrontation and supply disruption. Iran is believed to be covertly trying to develop a nuclear weapon, and Israel might be considering a pre-emptive military strike.

"A major curve ball can come from Iran," said financial planner Jacob Gold, author of "Financial Intelligence: Getting Back to Basics After an Economic Meltdown." Any showdown with Iran would likely be bearish.

"If someone tries to take out Iran's nuclear capabilities, it would throw the world into turmoil," said David Fondrie, senior portfolio manager at Heartland Funds.

Rising gas prices create a considerable drag on the economy, because the extra expense acts like a tax on consumers and siphons cash from other discretionary purchases.

Every 25-cent rise in a gallon of gas reduces other consumer spending by $25 billion a year and lowers economic growth by 0.2 percentage points, Deutsche Bank says. The average price of a gallon of gas is now $3.76, up 28 cents from a month ago, according to AAA. So if gas rises to $4 — like it has in three states already — consumer spending would take a roughly $50 billion hit.

"An average pump price of $5 would have a serious effect on confidence and create headwinds for the economy," noted Scott Wren, senior equity strategist at Wells FargoAdvisors.

2. Dysfunctional US Politics

Election uncertainty is another wild card. Is there more political gridlock ahead? Can lawmakers finally agree on a plan to reduce the nation's swelling deficit and get the nation's fiscal house in order? Will there be another 11th-hour standoff this fall over raising the federal debt limit? Will lawmakers extend the Bush tax cuts, which expire at the end of 2012? If the tax cuts are not extended, expect a drag on the economy, said Byron Wien, vice chairman of Blackstone Advisory Partners.

Perhaps more worrisome is the warning from Robert Rodriguez, CEO of money-management firm First Pacific Advisors: "If we don't start on a fiscal restructuring in this country by the end of next year, it is quite likely that between 2014 and 2016 we could experience something as big as Europe is going through today."

3. Inflation and Interest Rate Fears

A big plus for the financial markets has been the low interest rate environment fostered by the Fed and its chairman, Ben Bernanke. The steady low rate has nudged investors into riskier assets, such as stocks, in search of bigger returns. But the downside of the easy-money policy is a possible sharp rise in inflation . And inflation is an enemy of financial assets, said Jim Paulsen, chief investment strategist at Wells Capital Management. If the inflation rate, which is hovering around 2 percent, goes well above the current level, the market reaction might not be pretty.

"If inflation gets out of control there will be a violent reaction in the bond market and at the Fed," Paulsen warns. If the Fed starts to raise rates and bond investors sell and yields rise to compensate for higher inflation, the economy could slow, he says. That would make it harder and more expensive for the U.S. to finance its deficit, and stocks would likely suffer.

4. Economic Slowdown in China

If China's growth engine slows, the ripple effect could be felt globally. China this week lowered its growth outlook to 7.5 percent from 8 percent, where it has been since 2005. Slower growth there could hurt companies and countries that export commodities such as steel, concrete and oil to China.

5. Europe Debt Woes Resurface

For now, the threat of Greece defaulting on its debt — and the potential for a banking crisis and financial contagion spreading throughout the euro zone and beyond — has eased, thanks to a recent deal struck between Greece and central bankers, finance ministers, and creditors in Europe. The European Central Bank's move to provide 1 percent loans to banks in Europe has acted as a key backstop in stemming the crisis.

But the larger structural problemsof too much government debt and too little growth haunting many European economies persist. Markets will likely be dodging potential euro zone risks for years to come.

"Europe could unravel again," said Carmine Grigoli, chief investment strategist at Mizuho Securities USA.

Headwinds notwithstanding, by historical standards this 36-month-old bull is entering the later stages of its life span. The average duration of bull markets dating back to 1932 is roughly four years, according to InvesTech Research. That means this bull still has a shot at reaching its fourth birthday without suffering a bear market — or 20 percent decline — that would mark the end of its run.

Ironically, the celebration of the bull's third birthday coincides with a stock market that is showing signs of rally fatigue. The upward rise in stock prices has hit a wall. Since hitting key milestones, such as Dow 13,000, the market has stalled. Case in point: On Tuesday, the U.S. stock market suffered its worst drop of the year and first daily decline of more than 1 percent since December.

The combination of a loss of momentum following the S&P 500 index's nearly 25 percent rally since early October and the emergence of fresh obstacles to consider has many Wall Street money managers, analysts, investment strategists and financial advisers calling for a pullbackor correction .

Bob Centrella, managing partner at Forza Investment Advisory, sent a note to his clients this week warning of a shallow pullback of 3 percent to 5 percent. But he also warned of a bigger correction if tensions between Israel and Iran escalate or if Europe's debt crisis worsens.

"If war erupts in the Middle East, look out," he warned.

A major correction is what would put Bart Ruff, 48, a marketing brand manager from Lederach, Pa., in a stock-buying mood. But for now, he feels the market is due for a tumble. "I think the market is riding on hope," Ruff said. "Housing, jobs, Europe, politics. Things aren't stable."

David Wright, managing director of Sierra Investment Management, is even more bearish. "After a three-year rally, the market is extended, tired and overdone," Wright said. He said a pullback of 25 percent or more is possible.

But Wright and the other skeptics are in the minority. The general consensus is that, despite strong odds that a pullback will occur, the bull market is alive and well.

The bullish bet is based on the belief that the economic and jobs recovery will surprise to the upside. Optimists point to the fact that stocks are still selling at attractive prices relative to their earnings potential. Bulls also expect lawmakers to come together and take the needed steps to reduce the nation's debt load. The Fed's pledge to keep short-term interest rates at roughly zero percent until mid-2014 is seen as a boost for stocks.

"I think there's some toothpaste left in the tube," said Jack Ablin, chief investment officer at BMO-Harris Private Bank.

So how much does the bull have left in its tank?

Plenty, said Laszlo Birinyi, market seer at Birinyi Associates. "S&P 1,700!!!" is the title of his super-bullish March 2012 market report. That's almost 26 percent higher than Wednesday's close of 1353. In fact, he said, "If — if — the market is right and the economy surprises us on the upside" this bull could be as durable as the five-year bull market that began in 1982 and the decade-long rally that started in 1990.

Lewis Altfest, a financial adviser at Altfest Personal Wealth Management, said the market could post 10 percent annual returns for the next five years. "I don't think it is too late to get in," he said.

The mood of the market going forward might be determined by the government's February jobs report to be released Friday, added Jim O'Neill, chairman of Goldman Sachs Asset Management. If the economy, which has produced more than 200,000 new jobs each of the past two months, can produce close to the roughly 250,000 jobs a month economists are expecting, investors might firm up the belief that this economy is healing. "Friday's number could get people believing that the U.S. is in a sustainable recovery," he said.

Grigoli, the strategist with Mizuho, said stocks offer far more value than low-yielding bonds and that a rally could last three more years. "You can't fund retirement earning 0 percent on your money," he said.

Wendy Hunt of Cincinnati couldn't agree more. The 39-year-old mother of two and her husband have been rewarded for sticking with stocks through the crisis and riding them back up.

"We're fully invested in stocks," she said. "We've stayed close to Apple and Berkshire Hathaway. We're super happy with how our consistent faithfulness to the market has paid off."

This story first appeared in USA Today.