Happy birthday, bull market.
On Thursday, the US bull market will celebrate its eighth birthday. The second-longest rally in market history, its longevity is almost twice that of the median bull market – not something many would have foreseen back in the dark days of March 2009, when the mood among investors was apocalyptic following the worst bear market since the Great Depression in the 1930s.
Far from looking like it will die of old age, the bull market has gotten a new lease of life in recent months.
The Dow Jones has been hitting all-time high after all-time high, going on a winning streak that has broken all past records. Not since October has the S&P 500 suffered a daily decline of 1 per cent or more. Riskier and cyclical stocks have been leading the advance. Numerous sentiment surveys show investor bullishness to be at multi-year highs.
Sentiment had been largely muted among both ordinary and institutional investors for most of the eight years. Even if one accepts the premise that Trumponomics is good for stock prices, it doesn’t automatically follow that the return of animal spirits is justified. After all, the bull market is old.
Valuations look steep relative to history – various metrics suggest current valuations have only ever been exceeded during the dotcom era. Annualised returns have averaged 19.4 per cent over the last eight years, according to Howard Silverblatt of S&P Dow Jones Indices, and even the most ardent bulls would admit such returns are unsustainable going forward.
A late-stage rally?
Nevertheless, while it might not seem especially rational to only turn bullish following an eight-year rally that has seen stock prices more than triple, such behaviour is entirely in keeping with market history. Bull markets don’t peter out; rather, they go out in a blaze of glory, with some of the biggest returns accruing in the latter stages of rallies as speculative excess takes hold.
There has been precious little exuberance among investors in recent years, but that has changed since Donald Trump’s presidential election victory in November. Accordingly, many strategists argue the stage is set for a classic late-cycle bull market rally.
When will this end? Bears suggest the end might come sooner rather than later.
The huge valuation afforded to Snapchat parent Snap during its recent initial public offering (IPO) is reminiscent of past market tops, sceptics argue. They point to how Blackstone's 2007 IPO marked that year's infamous credit market top, just as metals giant Glencore went public in 2011, not long after commodity markets topped out.
However, the same argument was made at the time of Twitter's IPO in late 2013 and Alibaba's market debut in 2014. Similarly, countless dotcom stocks went public sporting crazed valuations in the mid-1990s, when then Federal Reserve chairman Alan Greenspan warned that markets were displaying "irrational exuberance", but stocks continued to soar until the bubble finally burst in 2000.
Today’s valuations are nowhere nearly as elevated as those seen in the late 1990s. As for the age of the current rally, it’s often said bull markets die of fright rather than old age.
What would constitute a serious market fright, one serious enough to trigger a sustained bear market decline of at least 20 per cent? Usually, a recession is needed to trigger a decline of that magnitude – eight of the last 10 bear markets have been accompanied by recessions, according to JPMorgan’s quarterly Guide to the Markets – but economists agree the odds of a 2017 recession are slight, to say the least.
Less common bear market catalysts include extreme valuations, aggressive Federal Reserve tightening and commodity price spikes, says JPMorgan, indicating there is little reason to fear a serious market downturn any time soon.
Timing the market
Still, there are no guarantees in markets; although the bull market may currently appear well placed to enjoy a ninth birthday and beyond, one never knows for sure.
Investors intent on timing markets always face the same dilemma. If they remain invested for too long, they run the risk of seeing their stocks suffer heavy declines, but if they sell too early they miss out on potentially hefty market gains. If you are going to try and time the markets, is it generally better to sell too early or too soon?
Merrill Lynch data shows that in six of the last 12 market cycles, the better option would have been to sell six months before markets topped than six months after. It’s better to be 12 months too late than 12 months too early, however, while the “sell too late” trade almost invariably beats the “sell too early” trade over a 24-month period.
Merrill’s data indicates that, more often than not, it pays to remain invested rather than cashing in too early.
Valuation, too, is of little use when it comes to assessing when the ongoing bull market will end. In 2013, the authors of the annual Credit Suisse Global Investment Returns Yearbook tested a seemingly commonsensical strategy whereby investors sold stocks when valuations clearly exceeded historical norms and bought back in when equities had become cheap. This “buy low, sell high” approach underperformed a buy-and-hold strategy in all 20 countries studied.
Does this mean that investors must stick with US equities, even if they are concerned by elevated valuations?
Not necessarily. Value investing fund giant GMO estimates that large-cap US equities will lose money over the next seven years while Research Affiliates is similarly cautious in its long-term outlook, cautioning that US stocks are priced to only barely beat inflation over the next decade.
Both firms have been cautious – too cautious – for many years now, but even ordinarily bullish names are concerned by current valuations. For example, Vanguard founder and buy-and-hold advocate John Bogle has also been sounding the valuation alarm, warning last year that after costs, US investors would be lucky to secure annualised returns of more than 2 per cent over the next decade.
One remedy for concerned value investors is to rotate into Europe and emerging markets, where valuations are much less heady, whilst retaining a weighting towards the US that allows them to benefit from a bull market that does not look likely to end any time soon.
As things stand, the absence of recession risk means the bull market may well celebrate its ninth birthday and beyond. As a long-term bet, however, the pricey US market looks set to disappoint investors.
