As of March the bull market is now five years old. That has many pundits turning to clichés like “long in the tooth” to describe the bull and where we may go from here. This bull market is now the sixth longest on record since 1928. Of the eleven bull markets since World War II, only three of them went beyond six years. So is this truly a reason for immediate concern?
The longest bull market on record began after Black Monday in October of 1987 and lasted over twelve years until the tech crash began in March of 2000 which was largely created by the dot com bubble. We believe it is reasonable to compare this longest bull to today’s market. Both began after horrific bear markets which led to valuations that were sure to deliver above average returns moving forward. Black Monday ended with investor confidence crushed and the market down well over 20% in one day. The bear market ending March of 2009 destroyed confidence as well and, even worse than 1987, caused genuine concern about total economic collapse.
We suggest that the worse the recession and the climatic end of a bear market, the longer the next bull market can last. There was nothing that shook confidence more than the last recession often called the worst since the Great Depression. Not only was the equity market down significantly but most everyone was affected by the severe drop in residential real estate valuation.
John Templeton once said that bull markets have four stages: They begin during a time of pessimism, grow during a time of skepticism, continue to rise during an optimistic stage and ultimately fail during the final stage of euphoria. We believe that we are now only in the skepticism stage with maybe only a toe or two in the optimistic stage. Each stage can potentially last for years. Investor sentiment is not strong and, though we have witnessed price to earnings ratio expansion, this market valuation measurement is only at average historical levels. The Nasdaq recently fell 9% quickly as some tech and biotech issues became extended and valuations are excessive. However, the broad market at 16x earnings is not overvalued which one would expect if we were further into the bull market’s optimistic or euphoria stage. Even the Nasdaq reversed course strongly last week as a strong intraday reversal turned it positive and further upside was confirmed by follow through in the days since.
Though the severe winter caused weak economic growth in the 1st quarter, GDP is still expected to improve as the year progresses. Many economists believe that U.S. economic growth as measured by GDP can reach 3% the balance of the year. Three percent GDP growth would correlate to 7-8% growth of S&P500 earnings. Even without further P/E ratio expansion, this would take the market higher by the end of the year.
In conclusion, the fundamentals always win. Currently earnings are still improving and are reasonably valued, interest rates are low and there is still plenty of liquidity for the market as confidence improves. Companies are flush with cash as a percentage of assets on their balance sheets. Last year was the second biggest year on record for companies buying back their own stock which further improves earnings per share. Maybe it is finally time for some of that cash to be spent on capital expansion? If so, we would see the slow growth of our economy begin to accelerate. Though some volatility has returned and is to be expected in short periods of time, avoid emotional decisions. We remain bullish intermediate and longer term.
Royal Fund Management, LLC
