Why aren't investors bullishly giddy?
Sep. 10, 2018 Commentary

The Slow Grind Up Continues— In Contrarian Fashion, We Remain Positive

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“Bank on the Trends and don’t worry about the tremors.” - J. Paul Getty

The Standard & Poor’s 500 index advanced a solid 3 percent in August, marking the fifth straight monthly advance for this widely followed U.S. equity benchmark. In addition, although it took almost seven months, this index finally hit another all-time high in late August, piercing through the previous high-level set back on Jan. 26, 2018. This flies in the face of warnings from various sources to expect the weak seasonal trends that can occur in the summer vacation months when many investors are away from the office. Of note, the media has been hyping news that, also in late August, the S&P 500 earned distinction as the longest bull market on record.

Given these events, you would think investors would be bullishly giddy at this point. Surprisingly, we find investors to be quite nervous and skeptical in spite of the continuing and very favorable economic backdrop and positive trends in the data. This is most apparent in the metrics on fund flows that show market participants continue to sell U.S. equities and increase their holdings in less risky money market instruments and bonds. No doubt, they are influenced by such recent negative headlines as: “The Bull Market Will End…The End is Near” (Fortune, July 2018) and “The Bull’s Final Countdown…How to Prepare” (Barron’s, July 2018). Additionally, the anxiety-inducing wall of worry items, including ongoing trade negotiations and risk of impeachment proceedings in a post mid-term world, also have had a negative influence on sentiment. For us, the solid fundamentals, coupled with a healthy dose of investor caution, is a nice recipe for additional gains in the market. Ironically, this optimism makes us contrarians to the leanings of the crowd at this stage.

“The Longest Bull in History” — A Dose of Perspective

Fact: It’s not the longest bull in history. 

While the media is pumping the current bull market as the longest on record, this just isn’t correct. Per Ed Yardeni of Yardeni Research, this observation is just plain bull. Specifically, the previous longest bull market being cited in articles that promote this “longest on record” theme supposedly extended from Oct. 11, 1990 to March 24, 2000. This assertion assumes there was a 20 percent bear market spanning from July 16 to Oct. 10, 1990 that preceded it. In fact, there wasn’t…the short (almost three month) correction in 1990, fell short of the technical definition of a bear market — a multi-month swoon of at least 20 percent. Yes, it fell 19.9 percent, but that’s not 20 percent...just as the 19.4 percent correction in 2011, that we seem to forget, did not meet the definition of a bear market either. So adjusting for this, the still longest bull market on record is the one that lasted Dec. 4, 1987 through March 24, 2000. This real longest bull market lasted roughly 4,500 days. The current secular advance is about 1,000 days short of that mark. We strongly argue against the fear around the length of this bull market and the hype that, because of its unprecedented age, it will end…soon. 

Fact: It’s Not the Strongest. 

The bigger point, though, is that stepping back from absolute age figures and technical definitions of a bear market, the magnitude of this current bull runs well short of previous maximum economic and stock price advances.

Economic Advance Far More Measured This Time, So Far: In terms of strength of this economic recovery, as the chart below illustrates, the 20 percent cumulative gross domestic product (GDP) growth since the prior economic peak in the fourth quarter of 2007 is well below the 30-50+ percent cumulative advances seen in over one-third of the prior expansions dating back to 1948. If history serves as a guide, we have far more runway for additional economic growth in this one.

Strength of Economic Expansions

Source: Strategas

Market Gains Well Below the Largest As Well: The cumulative price return in the “supposed” prior longest bull was 417 percent (close to 450 percent if you more accurately look at December 1987 as the beginning of that bull) versus the lesser 321 percent cumulative price return in the current bull. Again, based on magnitude, there is runway for further gains, from a historical perspective.

The Big Picture—The Wisdom in Examining Long Term Trends

The chart of the S&P 500 price trend going back to 1900 is my favorite chart for times when perspective on stage of advance or decline is helpful. It clearly illustrates that the market goes through multi-year to multi-decade periods of moving essentially sideways. These periods are marked by deep bear markets from which it takes years just to get back to even. Primary examples of this on the chart include the 1930s and ‘40s Great Depression era, the hyperinflation/stagflation period of the 1970s catalyzed by OPEC-related oil price shocks and the unusual duo of ugly six sigma events in the first decade of the new millennium — the bursting of the tech bubble in 2000 and the housing bust of 2008. 

The good news is that each of these has been followed by multi-year, multi-decade secular bull markets. As you can see, the S&P 500 only returned to even with the prior 2000 tech stock driven peak in 2013. U.S. equities were virtually a desert land for over a decade. It takes years to recover from something like this and we only resumed an upward advance a couple of years ago. The chart helps put this “longest bull market in history” chatter in perspective.

S&P Composite Index

Thank Goodness for the Wall of Worry 

We constantly maintain a healthy dose of paranoia while studying the rolling wall of worry that is in the headlines. Such items currently center around three basic issues:

  • The nasty trade rhetoric: Will this culminate in a trade war?
  • A potential Fed policy mistake: Too fast or too slow?
  • Ugly politics: Who will control Congress post mid-terms and calls for impeachment?

How do we think about each of these?  

Trade: Progress on the trade negotiation front has improved…particularly so with Mexico and Canada and the NAFTA discussion. The same can be said with tariff discussions with the European Union (EU). China is more difficult. Three major points on this topic: 

  1. Given the progress with our North American and EU trading partners, the Trump administration can focus on negotiations with China in a more “united with our allies” mindset instead of the “United States against the whole world” perception of only weeks ago.
  2. We are closely watching if the trade rhetoric is spilling over into sentiment and economic data via such paths as falling CEO confidence and capital spending plans. Currently, we don’t believe it is.
  3. Since negotiations with China may continue for some time, and announced U.S. tariffs may indeed go into effect, tactically we are a bit less positive on emerging market stocks.

The Fed: We believe they could be more measured than advertised. A September hike is almost certain, but they may pause and not hike in December as Fed-funds futures currently suggest. If the trade discussion lingers, or U.S. economic activity decelerates, the odds they hold off in December increase. We’ll watch for signs of policy mistakes via the economic indicators. Specifically, we watch for signs of yield-curve inversion, deterioration in both employment trends and key measures of economic activity, and falling CEO confidence that would signal risks of the Fed hiking too fast. Rising inflation and a surge in wage growth would signal the Fed is going too slow.

Politics: Majorities on either side of the aisle are likely to remain tight with limited impact on policy. Regarding impeachment, unless the GOP loses the Senate by a wide margin, we believe it is unlikely to impeach the president. In terms of history, there are only two prior periods from which to judge market impact. When Nixon resigned due to threat of impeachment in the early ‘70s, the market took a dive due to horrible economic conditions, not politics. Conversely, the market zoomed in the months prior and the months after the House of Representatives voted in favor of impeaching Clinton in 1998. Again, the positive stock price behavior was due to fundamentals which were spectacular at the time. The punchline is that it’s fundamentals, not impeachment we should worry about.

So, we embrace this wall of worry and are grateful we have one that is well advertised! This keeps valuation reasonable and investors measured. We worry most when there is no wall of worry! That’s when investors are truly complacent.

Wrap-up

The continued positive stance we are taking is surprisingly contrarian at this point because many want to predict the death of the bull, mainly because of its age. We embrace this contrarian view based on the trends in the data. To wit, employment data is nothing like you see at market tops. Unemployment claims are at a low extending back to 1969. The Consumer Confidence Index hit the highest level in 18 years in August 2018. CEO confidence continues to trend positively and is at healthy levels. This is driving a longed-for acceleration in capital expenditures and an improvement in labor productivity. Earnings and revenue growth are impressive. These simply aren’t financial trends typical at market tops. 

Don’t get us wrong, a short-term double-digit correction could occur at any moment based on the emotionally-based wall of worry items that can temporarily spook. We just don’t see these as actionable, and, if anything, would use them as buying opportunities. We think there are some significant wall of opportunity items out there that few are considering at present:

  • What if this threat of temporarily higher tariffs actually does work out to lower global tariff rates/protectionism in the long term and accelerate global trade and growth?
  • What if the considerable efforts to deregulate and cut red tape unleash a significant uptake in small business formation, profitability and employment?
  • What if the tax cuts and business investment incentives drive a virtuous cycle in capital spending?
  • What if technological innovation or a “Second Machine Age” based on artificial intelligence and machine learnings provides a major boost to productivity while keeping inflation at bay?

None of these are crazy upside surprises that could extend and boost the cycle. Few are looking for potential sources of upside at present. We’ll see. In the meantime, we continue to watch for deterioration in the data and will adjust our view if necessary. We don’t try and predict the predictors, but listen and watch closely for change in trend to influence our thinking and decision-making.

 

The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. It is not intended to be personal legal or investment advice or a solicitation to buy or sell any security or engage in a particular investment strategy. The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s comprised of 500 stocks chosen for market size and industry group representation. You cannot invest directly in an index.

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