The following is the S&P 500 chart in 2005.
*Read the entire history of the U.S. stock market here.
There was a weak inverse correlation between the S&P and oil in 2005. Sometimes the S&P would fall hard when oil rose a lot. Sometimes the S&P would rise when oil rose. Investors would have been better off by just ignoring the weak S&P-oil correlation. You couldn’t predict oil prices, and even if you could, you couldn’t predict how the S&P would react to oil.
Inflation (CPI) remained solidly above 3% for most of 2005 (after being under 3% for most of 2004). Historically, CPI becomes a short term trigger when it rises above 3%. This is because people start thinking about how CPI will impact future Fed rate hikes and how that will impact the economy. Although CPI impacts the stock market on the day that it’s release, this indicator has little impact on the medium-long term trend of the equities market.
The S&P went up in 2005 but in a very choppy manner. This is because various sectors of the economy were deteriorating. This was the first sign before 2007 that the U.S. economy was starting to slow down. The economic deterioration was especially pronounced in January – July and November – December 2005.
Overall, 2005 was very quiet in terms of political/economic crisis and news. The S&P tends to go up during quiet years.
There was a small 7.3% correction from March 7 – April 20. There were no fundamentals or news related to this correction. At first the media said “the S&P is down because oil is going up, so inflation fears are rising”. Then they said “the S&P is going down because oil is going down, so oil stocks are falling”. This just shows that most small corrections happen without any reasons. Our model was not able to predict this correction.
The small correction from August-October 2005 had no fundamental reasons/news. The media just made up BS excuse such as “rising inflation fears, more rate hikes, and higher oil prices are pushing the S&P down”. The last leg of this correction (October 4-6) coincided with 3 consecutive Federal Reserve Regional presidents (on 3 consecutive days) stating that the Fed would need to keep raising rates to combat inflation. The media foolishly attributed these 3 statements to the S&P’s decline from October 4-6.
It’s important to note that Hurricane Katrina had almost no impact on the S&P. There was no relationship between the S&P and Hurricane Katrina news (or news regarding the hurricane’s damage). Many investors attribute the 1907 bear market to the San Francisco earthquake of 1906. Clearly there was no correlation between those 2 events.
The housing market in 2005
The housing bubble was fully blown and near its peak in 2005.
“Nonprime” mortgages accounted for a staggering 25% of all loans in America, up from 1% in 1995. Subprime mortgages accounted for 20% of all mortgages issued in 2005.
Most banks, analysts, and mortgage originators made a crucial mistake. They believed that interest rates, economic growth, and employment were the key factors that determined mortgage default rates. Later studies (after 2008) showed that home prices are the main determinants of default rates. Many of these subprime mortgages were structured in a way so that many borrowers would default the instant housing prices stopped rising. Housing prices didn’t need to fall just to trigger waves of defaults – housing prices just needed to stop rising at such a rapid rate (7% per year from 2000 to 2005 compared to a historic norm of 1.4% per year).
Housing prices stopped rising by the end of 2005. In November 2005, a lot of banks (Deutsche Bank, Morgan Stanley, Bank of America etc) suddenly wanted to buy credit default swamps (insurance on mortgage defaults) because mortgage loans were going bad at an alarming rate. Shortly thereafter in January 2006, the U.S. house construction industry peaked and home-building began to decline.