James Quackenbush, BridgeTower Media Newswires
Last August the current bull market became the longest in history and exceeded the decade-long bull market of the 1990s. Since the Great Recession in 2008, monetary policy - through the use of multiple rounds of quantitative easing programs and ultra-low interest rates - has fueled the economy to the healthy state we witness today. In fact, GDP growth reached 4.2% in Q2, the unemployment rate has fallen to 3.7%, and consumer & business confidence are at levels not seen in years. These factors have all supported the longevity of this record bull market.
With the market already producing significant returns for investors and seemingly looking long in the tooth, many question how much longer this type of market action is sustainable. The old saying "bull markets don't die of old age" should be applied to today's environment. There is a tendency to look back at previous market durations as an indicator for when bull markets should end. Given the length of this bull market, history would suggest the end is near. However, there are strong fundamentals and momentum on the economy's side, which should continue to support GDP, earnings growth and higher market returns.
Early signs of a recession that could derail this market are currently not flashing any major warning flags. The ISM manufacturing index, which signals expansion when reading above 50, came in last month at 59.8 and has remained well above the expansion figure for the past two years. High-yield credit spreads, the spread between below investment grade bonds and Treasury bonds, would be increasing if the bond market expected an economic slowdown.
However, high-yield spreads are the narrowest they have been since 2007 at 3.4%. The Conference Board's Leading Economic Index that typically turns down before a recession is currently at an all-time high with a year-over-year change of 6.4%. The strength of the labor market also continues to be positive as job creation has been robust all year, averaging over 200k jobs per month, pushing the unemployment rate to the lowest it has been since 1969 at 3.7%. Lastly, the Federal Reserve (Fed) has been very cautious on the pace of interest rate increases, currently at 2-2.25%, are still low by historical standards and below the Fed's estimated neutral rate.
With so many positives generating excitement for market participants and the economy, investors should never become complacent and believe the current market environment will last indefinitely. There are always areas for concern, and today is no different. For example, Treasury yields have recently moved higher, causing volatility for stocks. Relations with China have deteriorated as tariffs and trade negotiations have created a severe risk to the markets and global growth. If tariffs persist for the long term, they will not only hurt the consumer and GDP growth, they could also generate an inflationary effect that may cause the Fed to act more aggressively with their pace of interest rate hikes.
Wage growth could also become an area of concern. Now that the unemployment rate is low, companies are finding it harder to fill open positions. Employers may need to offer higher wages to attracted quality workers. Amazon recently increased their minimum wage to $15 - again, adding to ensuing inflation concerns.
Earnings growth has been vigorous all year, exceeding 20% growth for the first two quarters. This has led to an increase in future earnings expectations, with analysts looking for 22% earnings growth over the next 12 months. These earning projections could be challenging for companies to meet or exceed. As mentioned earlier, wage growth - along with an increase in financing costs - could start increasing expenses, which would lower profit margins and bottom line earnings. If companies begin missing earnings expectations, it could put pressure on stocks and the overall market.
Now that the stock market has become the longest in history, fundamentals should continue to support the market for at least the next 6 to 12 months. Early warnings signs have not presented themselves. However, investors should always be aware of potential risks and not become complacent. Given the strength of this market, certain asset classes have performed better than others and investors should take this opportunity to rebalance their portfolios and manage their risk.
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James Quackenbush, CFA, is a senior domestic equity analyst for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534, (585) 586-4680.
Published: Mon, Oct 29, 2018
