Secular Bull Market Continues – Cyclical Move Becoming Mature
Jan. 8, 2018 Commentary

Secular Bull Market Continues – Cyclical Move Becoming Mature

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Our thematic work for 2018 has been entitled Rounding Third and Heading Home. Following last year’s theme (Acceleration) it appears, to us, that the U.S. economic and business cycle have become aged. While we are not yet ready to call the next recession, we need to understand that it has now been almost nine years since the end of the last recession. The U.S. economy has never expanded by more than 10 years without experiencing a recession. For a more full, detailed version of our economic and stock market outlook, please refer to last month’s commentary.

Economic recessions inevitably bring stock market bear cycles. Stocks don’t like declining profits, and one hallmark of an economic recession is a decline in corporate profits. But the actual timing of the next recession is some time off, in my opinion. 

Typically, stock prices tend to rise strongly 6 - 24 months prior to recessions. This could be the time frame we are currently experiencing. Stock prices have done very well over the last two-year periods.  Many on Wall Street are big believers in “mean reversion”. This concept suggests that over a long period, stock prices, interest rates and many other financial factors revert back to average, following periods of outlying behavior.

With this in mind, some believe 2018 will prove to be a difficult year for the overall stock market as market returns revert back to a mean, or average, return.

Stock market history does not jibe with this thought.

Histogram

Economists love charts and graphs. One type of chart they favor is a histogram. The histogram below groups stock market index price changes by amount of change and by year. Below each column of years is the range of price change for that grouping. How do you read this table? The column to the far left are years when the stock market declined by more than 20 percent. The column to the far right are years when the market increased by more than 20 percent. 

A simple histogram can inform the casual observer of many facts. First, it is apparent that there have been many more years when the market has generated positive returns than negative. Secondly, the entire chart has a “right lean” to it. This basically means stock prices tend to generate high, positive returns over the years, on average.  

As can be seen from the above, 2017 was a year when the Standard & Poor’s 500 index increased by more than 20 percent. Do stock prices swoon in the year following a year of strong returns? 

The histogram above shows the year’s return following a year, or years, when stock prices rose by more than 15 percent. Like the chart above, this histogram also has a right lean to it, meaning stock prices performed well even during years following strong upward shifts in stock prices. The return pattern during years following strong years suggests prices haven’t automatically collapsed because of a year of good returns. 

We suggest bear markets occur for fundamental reasons, primarily due to a collapse in corporate profit growth rates. We don’t see this type of collapse on the immediate horizon.

Price Volatility to Increase

With this all being said, we need to highlight our view that price volatility is probably going to rise this coming year. The expected increase in price volatility should be driven fundamentally by central banker’s actions of reducing the growth in liquidity in the world’s banking system. The Federal Reserve has been raising interest rates, and we suspect they will continue to do so as 2018 rolls along. The European Central Bank may eventually reduce their bond purchasing program. Lastly, inflation seems to be moving towards the Bank of Japan’s (BOJ) target, suggesting they will eventually slow their monetary easing program. 

Central bank-induced financial liquidity injections have acted as a buffer for the world’s financial markets going back to 2008. This shock absorber is slowly going away. This opens the door for more price volatility to occur in the world’s financial market pricing as 2018 unfolds. 

While stock prices may not crash due specifically to the rise in prices, we have witnessed over the last two years, prices may nonetheless witness a period of weakness, driven by a slowing in liquidity injections from the world’s central bankers. In the end, we continue to believe 2018 will be a year of continued market gains, albeit with a little more price volatility than we have witnessed over the last few years. 

This commentary is limited to the dissemination of general information pertaining to Mariner Wealth Advisor’s investment advisory services and general economic market conditions. The information contained herein is not intended to be personal legal, investment or tax advice or a solicitation to buy or sell any security or engage in a particular investment strategy. Nothing herein should be relied upon as such. The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. There is no guarantee that any claims made will come to pass. The opinions and forecasts are based on information and sources of information deemed to be reliable, but Mariner Wealth Advisors does not warrant the accuracy of the information that this opinion and forecast is based upon.

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