Summertime Wanes while Bull Market Waxes

Trade tensions, moderating global growth, political drama, rising interest rates that boost borrowing costs, and a gripe with Turkey and others – all be damned! While these matters may pose risks, they haven’t collectively prevented key stock market indices from claiming new highs.

Last week the Russell 2000 (small cap) index closed at new highs as did the S&P Mid Cap Index as well as the large and mega-cap index, the S&P 500. It took the S&P nearly 7 months to take out its previous high from late January. The S&P closed at 2,898 on Tuesday (August 28th), and appears that it’s only a matter of time before we pierce 3,000. Amazingly, 50 years ago (June, 4, 1968) the S&P first broke through 100!

Asset Class Returns since March 2009 - July 2018
Asset Class Returns since March 2009 – July 2018

Since March 2009 through late August 2018, the S&P 500 is up nearly 325%. While short-term risks have rocked the boat, U.S. stocks have outpaced other global markets – over that time, and particularly this year – on strong corporate earnings growth and more favorable economic fundamentals.

While this year’s rally had been largely driven by a few large tech names, as summer rolls along it’s become more broad-based than tied to a handful of stocks which is healthier for investors.

Let’s quickly look back as to what’s driven the market rally for the past 9 ½ years. Mainly it’s been fundamentals – record corporate profits; an expanding economy; an accommodating Federal Reserve that gave us quantitative easing (QE) and zero interest rate policy (ZIRP) to get the economy back on track (and today, rates are still low and rate hikes are gradual, encouraging investors to look to riskier assets); low inflation that supports higher valuations; record stock buybacks; and economic confidence that supports higher valuations.

What’s held investors back from truly embracing the rally? The Wall of Worry!

This bull market run has been questioned frequently as there have been lots of concerns to sidetrack one from sticking to their long-term investment aims and financial goals – European Union economic turmoil; U.S. federal debt downgrade; QE’s end; China worries; extended valuations; collapse in oil prices; Brexit; political turmoil at home; Fed rate hikes; trade tensions; and the occasional currency crisis (to name a handful).

Like a car, you drive by looking ahead not in your rearview mirror, so let’s look ahead. Barring an unforeseen shock, bear markets coincide with recessions. While we’re late in the cycle, leading indicators suggest odds of a near-term recession are low. Last week the Atlanta Fed raised their estimates for 3rd quarter GDP to +4.6%, marking an economy that’s getting stronger.

GDP Growth - Economic Growth on Pace for Best Year since 2005
GDP Growth – Economic Growth on Pace for Best Year since 2005

Stock fundamentals, while stretched, remain favorable. Today’s forward price-to-earnings (P/E) ratio for the S&P 500 is 16.6, according to FactSet. While it’s above the 5-year average of 16.2 and the 10-year average of 14.4, it’s high but not unreasonable. Low inflation and low interest rates support higher valuations.

Corporate Earnings Growth - Actual and Expected
Corporate Earnings Growth – Actual and Expected – By Quarter – as of August 2018

There is a lot of speculation about when the bull market will end. While I continually look for signs or the symptoms of an impending recession, I don’t see them now. Some are worried about the yield curve inverting (that is the term premium going away – or the extra yield that investors require to commit to holding longer-dated bonds than shorter-term bonds).  We still have further to go before the 10-year Treasury minus the 3-month Treasury spread inverts (2.87%-2.11%=+0.76%, as of August 28, 2018). The Fed could raise rates by another 1.0% over the next 9 months, so it’s important to monitor easy financial conditions as they gradually start to tighten. I’ll be paying attention as rising interest rates and wage inflation begin to weigh on peak corporate profit levels. Perhaps this is as good as it gets?! (reminds me of a Jack Nicholson movie 20 years ago).

Record Profit Margins of 9.73%, Net Income Relative to Sales for S&P500 through 2q2018 Earnings Season
Record Profit Margins of 9.73%, (net income relative to sales for the S&P 500 though 2q2018 earnings season) Source: Nuveen, LLC

If you’re an investor that has maintained a diversified, disciplined approach to investing over the duration of the bull market, you have benefited and should be applauded for sticking to your plan. One thing is certain, markets move in cycles and giant beanstalks don’t grow into the clouds. As such, the key is to make sure that your financial plan has the right asset allocation to help you keep moving toward your long-term goals as the market keeps moving too. Let me know (or one of my fellow advisors) if you have questions, happy to help.

Enjoy the vestiges of summer and your Labor Day weekend; I hope it’s relaxing and fun. And if you have kids/grand-kids, I wish them a good school year ahead. For me, it’s kick-off to football season and I’m ready to cheer on my favorite teams. In San Francisco autumn means warmer, sunnier days ahead than the persistent fog bank that’s called summertime.

Eric Linser, CFA

Author: Eric Linser

Eric Linser, CFA, is a San Francisco-based Private Wealth Manager with Green Valley Wealth Advisors, an affiliate of Naples Asset Management Company, LLC, a federally registered investment advisor (RIA). Eric’s expertise is in providing comprehensive wealth management services such as investment counseling, financial planning, and retirement plan services to individuals, families, businesses, and foundations. A particular focus is on generating income for retirees, and keeping savers on track to fund future goals. For over two decades, Eric has helped provide wealth planning guidance so that his clients could achieve financially secure retirements. He is trained, experienced and credentialed to design and execute a plan that best meet your aims. Plan for your future; invest in what matters.

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