Seven: Happy Anniversary Bull Market (?)
- Few celebrations were had about the bull market’s anniversary…perhaps because it’s not actually official?
- The market’s rally off the February lows has been impressive and looks healthier than last fall’s.
- But although there are many pros for investors to cheer, there remain cons for investors to ponder.
Last week we celebrated the seventh anniversary of the U.S. bull market, which commenced on March 9, 2009 and has since generated a total return for the S&P 500 of 247%. The traditional gift for the seventh anniversary is copper, which is fitting since the strong rally many “risk-on” assets have staged since U.S. stocks bottomed on February 11, has been accompanied (driven?) by a surge in commodities, including copper and more importantly oil.
But before I go deeper into an analysis of the year so far, do note that the bull won’t officially have surpassed its seventh anniversary unless the S&P 500 takes out the all-time high on May 21, 2015. If instead of moving higher to that level, the correction resumes and becomes a cyclical bear market (with a drop of at least 20%), the bull market will go down as having concluded last May.
So, the reality is we’re actually in limbo in terms of market semantics. I’m no better a market timer than anyone else—and never suggest investors should attempt to do so—but I think the market is more likely to officially hit the seven year point than it is to suffer the mauling of a new bear. But volatility is likely to remain a persistent trait of the maturing bull.
After a brutally weak start to the year, the rally since the February 11, 2016 low (when the S&P 500 was down 12.8% from its May 2015 high) has been impressive. Over that same period, many risk assets have rallied sharply.
Technically, the S&P is in good shape, having moved back above its 200-day moving average.
But all is not rosy. I’d define the landscape as generally favorable, but with ongoing risks which could ignite volatility at any time. Here are a sampling of the pros and cons for U.S. stocks.
Pros (with some caveats)
Recession risk has ebbed significantly, with market-based macro indicators (e.g., stock prices and high-yield spreads) having reversed much of their prior weakness. Initial unemployment claims—a leading economic indicator, like the stock market—remain in a very strong downward trend. That said, investor sentiment—a contrarian indicator—has not rebounded consistent with the market’s recovery from the recent lows. Investor fear is subsiding, but this bull market remains quite unloved.
Global central bank stimulus remains ample; while the Federal Reserve is likely to hold off on a March rate hike. However, in the face of rate hike expectations moving up for subsequent Federal Open Market Committee (FOMC) meetings, the market has performed well. As of last Friday, futures market-based expectations were up to near-50% for a hike in June, and were up to 77% for a hike by year-end.
Why hasn’t this upended stocks? The conditions for rate hikes being back on the table—inflation trending higher and job growth still robust—are favorable for stocks. Although inflation is often seen as a bogeyman for stocks, it’s not typically until inflation overheats that trouble ensues. In the meantime, higher inflation takes deflation risk off the table—which is typically toxic for stocks.
In deflationary eras, a pickup in inflation—and in turn bond yields—has been positively correlated with stock prices. As you can see in the chart below, we are in one of those eras. The U.S. 10-year Treasury bond yield started 2016 at 2.27%, but subsequently plunged to 1.66%-- not coincidentally on the same day stocks bottomed. Since February 11, bond yields are back up to just under 2% and stocks have rallied.
Oil has helped propel stocks higher as well. The International Energy Agency (IEA) said Friday that oil might have bottomed as production declines accelerate in the United States and other non-OPEC countries. Caveat: Too much of a “good” thing (higher oil prices) could eventually become a negative for U.S. economic growth, but for now, stocks and oil prices have a positive correlation.
Value has been outperforming growth; which typically happens when economic growth picks up. Small caps have also led out of the market’s low, suggesting domestic growth is improving relative to global growth. Also confirming the better economic story, cyclically-oriented sectors—notably financials, materials and industrials—have been the market’s leaders since February 11. And the U.S. dollar has rolled over, putting less pressure on U.S. exporters and helping support commodity prices.
In addition, the stock market’s “internals” have been improving with market breadth much healthier than what was seen coming out of the October rally last year. This means that the rally is supported by many stocks; unlike the small handful (i.e., the “FANG” stocks) which were propelling stocks last fall. And given the high correlation between high-yield bonds and stocks, the rally in high-yield bonds has signaled lower stress, while also helping propel stocks higher.
According to Bespoke Investment Group (B.I.G.), as of Friday’s close, nearly 90% of S&P 500 stocks were trading above their 50-day moving averages. That’s an extremely high and rare reading for this widely-followed breadth measure and argues for continued market gains over the next few months based on historical precedent.
Finally, March and April have historically been strong months for stocks, so seasonal tendencies remain favorable. April has historically been the second-best performing month, with an average return since 1950 of 1.5%; with March not far behind at fourth-best and an average return of 1.2%. Caveat: This by no means suggests history will repeat itself.
S&P 500 earnings growth remains negative, with the consensus for this year’s first quarter at -7%. With global growth still weak, and the OECD’s global leading economic index (LEI) deteriorating, multi-national corporate earnings are unlikely to turn up near-term. At the same time, small business optimism declined last month as highlighted in the survey from the National Federation of Independent Business (NFIB).
Valuations are not rich historically, but they have rebounded alongside the market. Without the benefit of rising earnings growth, valuation expansion is much less likely. At the same time, corporate profit margins have likely peaked.
Although job growth remains healthy, the Fed’s Labor Market Conditions Index (LMCI) recently moved into negative territory. This suggests the pace of improvement in the labor market could ease (albeit taking pressure off the Fed to raise rates). And although corporate stock buybacks are yet again running at a record pace, individual investors continue to expel U.S. stocks from their portfolios (via mutual funds and exchange-traded funds).
Election year uncertainty … enough said.
For now, the pros outweigh the cons; and it’s generally served well those investors who default to optimism over the long-term. But investors should also be mindful of the perils of greed (just as there are perils of fear and panic). Significant rallies offer investors opportunities at times to rebalance portfolios.
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All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.