10 years into the bull market are we close to a crash?
The current bull run has lasted close to ten years or to put it another way, it has been 3,453 days since the last bear market, defined as when stocks lose more than 20% of their value.
Those with the conviction in March 2009, when the S&P 500 hit 676.53, to buy against the market are likely to have made large gains – the index has risen by more than 300% since that time.
The question on investors’ lips is, can the bull run continue?
The strength and length of the run have their origins in the severity of the downturn a decade ago, says Will Hobbs, Head of Investment Strategy at Barclays Smart Investor.
“The related decline in US corporate profits in 2008/09 was the largest proportionate fall on record, larger even than that seen in the Great Depression. However, the cause of this dramatic fall in earnings was also the seed of their dramatic bounce. Write downs of financial assets at banks, insurers and some large manufacturers with substantial financing departments trounced corporate earnings as they travelled from balance sheet through the profit and loss statement. However, such write downs were only ever going to have a transitory effect, once the write downs stopped, the weight was lifted and earnings flew.
A significant factor was, of course, quantitative easing (QE), points out Carolyn Bell, investment manager in Kames Capital’s equities team. “National banks supported economies and asset values by pushing money into world markets, and by doing so they made large strides in improving consumer balance sheets in many regions.”
However, she points out, this has been at the cost of weakening national balance sheets, with US debt/GDP more than doubling from its relatively healthy 40% level in 2007, pre the Global Financial Crisis. As Q.E. is being dialled back, US equity investors have generally taken this to be positive – “an indicator that the US economy, and possibly the global economy, is ready to be weaned off its reliance on central bank funding.”
“In a true oddity, the S&P 500 was up every month of last year – the first time ever. Among the other hats he wears, Trump is Mr Deregulation – the markets have voted accordingly,” she adds.
“The vital statistics of this bull market are impressive,” says Adrian Lowcock, head of personal investing, Willis Owen. “However, although we now have the longest bull market on record with the second highest total returns, the annualised return looks less impressive when compared to those of other runs.”
This highlights how this bull market has been more drawn out, he says, arguably having been extended due to “the impressive growth in corporate earnings, which received a boost from Donald Trump’s fiscal stimulus programme”. S&P 500 companies produced nearly 25% earnings growth in the second quarter of this year, he points out.
So will the bull run continue?
“Recessions and bear markets tend to go together – while the economy continues to grow, the bull run should continue,” Hobbs says. “However, humility is appropriate here. Our ability to accurately call recessions is very limited.”
However, he points to “the fact that private sector scar tissue and a suitably chastened banking sector are only just starting to more visibly recover” as factors, amongst others, suggesting that there is scope for the recovery to go further yet – “the wild cyclical hubris that tends to precede the worst recessions is so far substantially absent,” he adds.
Bell is equally positive. “Bull markets end when such confidence becomes over-exuberant, generating imbalances and egregious valuations. We are not there yet. Capex levels are still modest, though rising, and equity risk premiums around 5% are still generous. The S&P 500 trades on a 16.6x price/earnings ratio, with a FCF yield of 5.2% and a dividend yield of 2%. While the US may seem expensive relative to other markets, it is not expensive relative to its own trading history.
In addition, she says fundamentals continue to be very supportive. “US companies (ex-financials) have record cash on their balance sheet, close to $1,400bn in aggregate at the end of 2017 versus $600bn approximately in 2008. The growth of the technology sector in particular has improved the cash-generating capabilities of the entire US market. So much cash suggests more M&A, more reasons for the market to rise. The latter stages of a bull market can sometimes be the most rewarding.”
Lowcock believes while valuations are high, “they have been for some time and markets can remain overvalued or undervalued for extended periods.” However, he points out, “market peaks are created not by overvaluation but by an event or situation that causes investors’ perspectives to change, making them lose confidence or become fearful.”
Hobbs believes there is still energy left in the bull . “The record-breaking nature of the recession experienced by the US and world economy between 2008 and 2009 perhaps always suggested that the recovery from those depths would be similarly record breaking in nature.
“Liquidity and sentiment are overestimated factors in this bull run. Having a portfolio that is designed specifically to weather recessions and bear markets is one of the most common, but understandable, investing mistakes of this economic cycle. The truth of the world economy and its related capital markets is that growth is the norm, not the exception.”
Bell emphasises that the ‘longest bull market’ appellation “is largely symbolic (it certainly doesn’t mean the market is expensive, or poised to fall), but it is probably a good point to take stock”.
The key risk the Kames capital team see, she says, is political risk. “From trade tensions to the populist rise (again!) in Europe and with the recent turmoil in Turkey signalling fragility in some emerging market corners, political risk has certainly taken more centre stage this year than in low volatility 2017. To pursue an aggressive isolationist policy for much longer would certainly be an own goal for Trump. The base expectation has to be that he is using strong-arm tactics as a means of negotiation.” Business, and markets, she points out “like political stability”.