Can the bull market continue?

30 August 2018

What has been driving the bull market, and will it last?

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. The past performance of investments is not a reliable indicator of their future performance.

What you’ll learn:

  • How much this bull market has returned to investors.
  • What the main drivers of this bull market are.
  • How much longer this bull market can run.

If the level of the S&P 500 is the number that best describes the degree of US economic virility, then the moment that it sunk to 666 on 9 March 2009 surely needs little further context. Unsurprisingly, there was no-one calling for this point to mark the beginning of a decade long record bull market in stocks, returning over four times an original investment.

Quite the reverse. Many well respected talking heads were calling for further sharp losses. One hedge fund manager even admitted to advising some well off clients to buy shotguns to protect themselves against social unrest if the market fell any lower. This week we look at some of the reasons why the stock market has risen so far, for so long, and whether it can continue.

Why the record bull run?

Stock markets are primarily based on the path of corporate profits. Most years corporate profits grow, much like the underlying global economy, so share prices and total returns follow suit, all things constant. Nonetheless, when looking for explanations for why stock markets make significant and sustained moves, corporate profits are usually your starting point.

This focus allows us to sideline some of the more common explanations for this record bull run which centre on Quantitative Easing (“QE”), share buy backs and, latterly, President Trump. In reality, the strength and length of this bull market has its origins in the severity of the downturn a decade ago.

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. Some measures of earnings fell by over 90% between mid 2007 and early 2009. 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.

However, when the write downs stopped, some very large negative items disappeared from profit and loss statements resulting in a proportionally faster rise in corporate profits – a 90% fall was followed very swiftly by an eight-fold rise in corporate profits the next year. US corporate profits are now 15 times higher than the low point reached in 2009, as companies have benefited from a world economy that has consistently confounded its many detractors.

QE certainly played a role in helping the economy find its feet again and, in lowering interest rates, has surely supported valuations. However, the absence of the kind of stock market exuberance that characterised the end of the last millennium suggests that this has been a supporting rather than centre stage role. For their part, share buybacks can only feasibly explain a tiny proportion of the returns.1

Meanwhile, this US administration has certainly presided over a jump in corporate profits, but there remains justifiable scepticism as to whether the recently enacted tax bill has changed the trend in economic growth or corporate profits, which is the more important point to consider for investors.

What next?

You might argue that the record-breaking nature of the recession experienced by the US and world economy between 2008 and 2009 always suggested that the recovery from those depths could be similarly record-breaking in nature. The fact that private sector scar tissue and a suitably chastened banking sector are only just starting to more visibly recover is among the factors suggesting that there is scope for this recovery to go further yet – the wild cyclical hubris that tends to precede the worst recessions remains substantially absent so far. Recessions and bear markets tend to go together – while the economy continues to grow, the bull run should continue.

As always humility and, its investing counterpart, diversification, are appropriate here. Our ability to accurately call recessions is very limited. The International Monetary Funds’ analysis of recessions in the developed world since 1960 only managed to find triggers for half of their sampled recessions – the remaining half were unexplained. Even so the indicators that have traditionally been of some use in predicting recessions are not currently flashing amber, suggesting that there is room for this bull to run further yet.

While it is almost impossible to predict when this bull market will peak with any degree of certainty, history also shouts of the rewards that have accrued to the long-term approach. The chance of the market going up or down on any given day has historically been equivalent to a coin flip, roughly 50-50. However, over the long run, investors have been much more likely to experience a positive return, with one and five-year returns positive 80% and 90% of the time, respectively.

How to prepare for the end

In such a context, building a portfolio that is designed specifically to weather recessions and bear markets is one of the most common, but understandable, investing mistakes. The truth of the world economy and its related capital markets is that growth has long been the norm not the exception. Recessions have been becoming less frequent and severe over time in spite of appearances and much commentary. Long term investors should simply ignore recessions and focus on the prospects for growth, which remain reliably founded on man (and woman) kind’s continuing restlessness and ingenuity.

These are our current opinions but the future, as ever, is uncertain and past performance of investments is not a reliable indicator of future performance.

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