How This Bull Run Will End

This bull market won’t last forever—but it won’t end without a reason

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Many stock investors are feeling a bit nervous these days. At more than eight years of age, today’s bull market is the second longest on record. The S&P 500 index has risen more than 250 percent from its bottom in 2009, making U.S. stocks more expensive than the historical average by several measures.

It’s easy to assume that what goes up must come down, especially for investors who recall the 2008 financial crisis and 2000 dot-com bust. But “bull markets don’t die of old age,” says Krishna Memani, chief investment officer and head of fixed income at OppenheimerFunds. “Bull markets die when their system can no longer fight off their maladies.”

In other words, a bull market must experience a catalyzing event to turn bearish, Memani says. History shows that only certain kinds of catalysts have this effect. And while nobody can predict exactly when a market will turn, Memani and his team don’t see signs of such catalyzing events on the near horizon. That gives them confidence that this bull has a way to run.

A Global Expansion

Markets can experience a temporary setback for just about any reason. But a sustained bear market usually requires a recession, because slow economic growth hurts the corporate earnings on which stock values ultimately rely. Fortunately, “for the first time since the 2008 financial crisis, the major economies of the world are expanding in unison,” notes Brian Levitt, senior investment strategist at OppenheimerFunds.

At the global level, worrying events such as the European sovereign debt crisis and the slump in emerging markets are behind us. In the U.S., there are few of the signs of excess in the business cycle that have presaged previous recessions. Bank credit growth, inflation, and household debt levels are all subdued. And U.S. stocks are still inexpensive relative to bonds.

Good Times for Global Economies

An indicator of the end of this bull market would be the deceleration of major global economies. But there's no sign of this slowdown. Instead, the world's major economies are now growing at a reasonable clip.

Year-Over-Year U.S. Wage Inflation and Growth Percent Change

e.u.

-1%

2%

4Q

2012

2Q

2017

u.s.

1%

3%

4Q

2013

2Q

2017

japan

0.5%

1.7%

4Q

2014

2Q

2017

emerging
markets

4.2%

5.2%

4Q

2015

2Q

2017

china

7%

7.2%

4Q

2016

2Q

2017

Worst quarter of real GDP1 growth since 2008

Recent quarter of GDP1 growth

Year-Over-Year U.S. Wage Inflation and Growth Percent Change

Source: Bloomberg, 8/14/17. Past performance does not guarantee future results.

Central Banks at Bay

The market could also turn if the U.S. Federal Reserve raises interest rates too hastily. When central banks raise interest rates, lending is dampened, which has a knock-on effect on economic activity and earnings. Rising interest rates also increase yields on bonds—which makes stocks less appealing by comparison.

But central banks usually raise rates in order to control inflation. And by many measures, inflation is not an imminent threat. Wage growth is stagnant in the U.S. and Europe. And while both the U.S. and Europe are tightening their monetary policy in response to their strengthening economies, they are doing it gradually. That’s a reassuring sign to investors.

U.S wage growth remains weak, keeping a lid on inflation.

Inflation has undershot the Fed’s target for 59 straight months, even as the unemployment rate has more than halved. The Phillips Curve, the supposed inverse relationship between the level of unemployment and the rate of inflation, is proving to be flatter than in the past. The rationale, as expressed by Federal Reserve Board Governor Lael Brainard, is that America’s labor market is not as strong, nor as tight, as the 4.4 percent unemployment rate suggests.

Year-Over-Year U.S. Wage Inflation and Growth Percent Change

4.5%

2.8%

1967

7.5%

7%

1977

2.8%

4.5%

1987

4%

1.8%

1997

4%

4%

2007

2.8%

1.5%

2017

U.S. Average Hourly Earnings
(Production and Non-Supervisory Workers)

Consumer Price Index

Year-Over-Year U.S. Wage Inflation and Growth Percent Change

Source: Bureau of Labor Statistics, 11/30/17. Past performance does not guarantee future results.

Yield Curve Remains Relatively Steep

One of the most reliable predictors of a recession is an inversion of the “yield curve,” which tracks the variation between long-term and short-term yields on Treasury bonds. When the yield curve is inverted, long-term yields are lower than short-term yields—the opposite of the norm. It signals that investors are reluctant to buy short-term Treasury bonds because they fear that the economy will overheat, forcing the Federal Reserve to raise short-term interest rates and reducing the value of those short-term bonds.

Banks usually offer low yields on deposits and lend at higher, long-term interest rates, notes Levitt. When the yield curve inverts, banks have less incentive to lend to consumers and businesses, which ultimately stifles the economy. But fortunately, “the yield curve is steep enough right now to promote credit growth and extend this market cycle,” Levitt says.

One early sign of slowing credit growth is the widening of the “spread” between the bond yields offered by companies with low credit ratings and the yields of lower-risk Treasury bonds. When these “junk bond” issuers must offer ever-higher yields, it’s a sign that investors are worried they will default in the future. But high-yield credit spreads are currently below the historical average—another apparent positive for the bull market.

Short-Term Rates Vs. Long-Term Rates

Bull markets historically end following a series of interest rate hikes by the Fed, a flattening of the U.S. Treasury yield curve and ultimately an inverted curve. As of December 2017, the federal funds rate is at 1.5 percent while the 10-Year U.S. Treasury rate was 2.5.

2019

2018

2017

0 2 4 6 8% 2017 2015 2013 2011 2009 2007 2005 2003 2001 1999 1997 1995

Federal Funds Rate2 Target

10-Year Treasury Yield

Fed Funds Rate2: Median Projection of Federal Open Market Committee Members

Source: Bloomberg, Haver, 7/31/17. Federal Reserve Bank of New York, Board of Governors of the Federal Reserve. Past performance does not guarantee future results.

Staying the Course

For these reasons and many others, investors shouldn’t assume that some kind of gravitational force will inevitably spell the end of the current bull run. Nor should they succumb to the belief that some headline-grabbing event will do the same. The stock market has stayed on a long-term upward trajectory for decades, through wars, natural disasters, terrorism and political turmoil.

While it’s possible to detect market patterns and trends, no one has a crystal ball. Investors who jump into and out of the market based on predictions risk losing out on the market’s best days. Instead, Levitt recommends, investors may want to choose a stock allocation for their portfolios that is based on their goals and risk tolerance and stick with it. “Investors who want or need to generate growth should be in equities for the long term,” he says.

Nonetheless, an understanding of market cycles can give any investor a useful sense of perspective.

For a more detailed discussion of market catalysts—including many more indicators to watch—OppenheimerFunds will periodically update its “early warning dashboard” tracking the most important signs of an end of the current market cycle.