Is Another Bear Market Around the Corner?
This question is on many investors’ minds today. In 2014, stocks have risen against a backdrop of morphing fears, like geopolitical tensions, which have flipped from place to place: Ukraine and Russia; Israel and the Palestinians; Iraq and Syria. Folks fixate on central bank releases, putting word choice under a microscope—like September’s debate over whether the Federal Reserve would delete “considerable time” from its policy statement. Yet through September 25, the U.S.-based S&P 500 Index is up almost 8% and the MSCI World just over 4%.i Our assessment of the three key drivers of equity markets—economic, political and sentiment drivers—point to continued bull market through 2014’s close and likely beyond.
Midterm elections loom, likely bringing an increasingly gridlocked government. Historically, gridlock has been a plus, as it means Congress can’t push sweeping legislation potentially affecting markets materially. But investors, caught up in heated campaign rhetoric, are generally slow to appreciate this. Not until elections are dead ahead do investors realize campaign talk likely won’t become law. This gradual realization results in a high frequency of positive Q4s in midterm years and the subsequent Q1 and Q2. S&P 500 total returns have been positive 86.4% of the time since 1926 in each of these three quarters (that the frequency is identical for the three is coincidence).ii This is well ahead of the S&P 500’s overall frequency of positive quarters, 67.4%.
Optimism grows, but skeptics remain—often suggesting the bull’s above-average age and magnitude mean its days are numbered and stocks will soon fall. Historically, bull markets have ended for many reasons, but age and magnitude aren’t among them. Other skeptics cite record highs as a risk. But record highs are not synonymous with peaks. In the 1990s, the S&P 500 closed at a new record high 347 times—153 in the 1980s.
Exhibit 1: 1990s Bull Market Record Closes
Source: Global Financial Data, as of 01/22/2014. S&P Total Return Index Level, 07/16/1990 – 03/24/2000.
Exhibit 2: 1980s Bull Market Record Closes
Source: Global Financial Data, as of 01/22/2014. S&P Total Return Index Level, 11/28/1980 – 08/25/1987.
Economically, corporate profits are up, fueled by rising sales. The Conference Board’s Leading Economic Index is rising, alluding to continued economic growth. Lending has picked up since the Fed began winding down its quantitative easing program—a factor we expected as a wider yield curve boosts the profitability of bank lending. This is fuel for growth, and a growing economy will increase both corporate profitability and, given time, investor confidence.
Euphoria doesn’t seem near—illustrated by acrophobia, geopolitical concerns and monetary policy worries. Bull markets typically run until they naturally lose energy in a euphoric peak (like 2000’s tech bubble) or are cut short by some external force (2008’s accounting rule change and government actions). There is little sign of either today.
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i Source: FactSet, S&P 500 Total Returns and MSCI World Index including net dividends, 12/31/2013 – 09/25/2014.
ii Source: Global Financial Data, Inc. S&P 500 calendar quarter frequency of positivity, 1926 – 2014. As of 07/23/2014.