Current market rally is one for the ages
On the silver screen and within the pages of pop fiction, the scariest moments often are those when the action stops and nary is peep is heard.
“It’s quiet out there,” someone finally whispers. “Too quiet.”
Nervous investors have mouthed those same words recently about stocks, as equity prices inch ever higher at sub-glacial speed while making all the noise of a church mouse.
The rally that began in the dark days of the global financial crisis is one for the ages. At eight years and six months, it ranks second in duration and second in total return among the dozen bull markets since the mid-1940s.
And, with economic activity gaining traction overseas, international markets are joining in the bounty.
Jeffrey Kleintop, chief global investment strategist at Charles Schwab, noted that for the first time, an index of world stocks this year posted gains in each month through September.
As remarkable as the bull’s market’s longevity and heft has been, its lack of volatility might be even more remarkable.
According to Ned Davis Research, the S&P 500 at the end of September had gone 318 days without a drop of 5%, compared with an average of 50 days since 1928; gone 412 days without a correction of 10%, compared with an average of 167 days; and gone 2,157 days since the last decline of 20%, compared with and average of 635 days.
The maximum annual pullback over each of those nine decades averaged 11.48%, or quadruple the largest decline sustained by U.S. equities this year.
Such serenity does not come without risk.
Periodic market selloffs function to shake out weaker holders, paving the way for the next leg up. Downside volatility also discourages speculative excesses that almost always end badly. Yale University professor Robert Shiller found that equity market volatility was below average in the 12 months preceding each of the last 13 bear markets.
The absence of downside volatility — the last decline of any significance was in June 2016, following the British vote to leave the European Union — is even more striking given the dysfunctional U.S. political environment and geopolitical risks on the Korean peninsula.
Interest rates rule
As Warren Buffett often has noted, the most important factor in establishing an equity market’s fair value is not the pace of economic growth or even corporate profits, but interest rates. Whether stocks are worth owning depends on whether their expected 10-year return beats the competition, as measured by the yield on the 10-year U.S. Treasury note.
From current levels, the U.S. equity market probably won’t match its historical average of roughly 10% per year over the next decade. Memories of the valuation bubble in the late 1990s still linger, and investors are unlikely to repeat that mistake.
Still, it is a reasonable bet that stocks will do better than the 2.35% return currently found in the government bond market.
The lack of recent volatility can be traced to the low — some would say, unnaturally low — interest rates engineered by the Federal Reserve to nurture the economic recovery. Aware of the strong structural headwinds that continue to impede global economic growth, and with inflation remaining dormant, the Fed has moved slowly to normalize monetary policy.
Such caution has been especially pronounced since 2013, when financial markets threw a “taper tantrum” after Fed Chairman Ben Bernanke revealed plans to scale back, or taper, the central bank’s purchase of government bonds. Bernanke’s successor, Janet Yellen, has taken pains to telegraph the Fed’s every move, both in regard to benchmark rates and bond purchases.
Without the fear of being blindsided, investors feel confident in ignoring current valuations that by one measure (Shiller’s CAPE ratio) have been surpassed only twice since the mid-1800s.
No one can predict when the next correction will strike, or what will trigger it.
There is no shortage of candidates, beginning with North Korea and including unrealistic expectations about fiscal stimulus, a potential constitutional crisis related to Russian interference in the 2016 election, the effects of an aging business cycle on credit quality, and more hawkish leadership next year at the Fed.
But for now, it’s quiet out there. Maybe too quiet.