Bull run is far from galloping to a halt

OVER the past five years, equities have been the place to be. The JSE, for example, rose 259% in that time, while the S&P 500 index in the US was up 247%.

The five-year bull run has been fuelled by record low interest rates and massive injections of capital by the US Federal Reserve in the wake of the 2008 subprime crisis.

The problem is that these conditions are now coming to an end with the Fed tapering the amount of liquidity pumped into the system and a possible rise in the Fed fund rate in 2015 — the first such hike since 2004.

This normalisation of monetary policy, taken together with the new record market highs, has sparked concern among investors that the bull run is over and that we are now in a stock-market bubble and heading for a massive correction.

The good news, however, is that when you look at the forces driving these markets, the odds are actually in favour of markets moving higher.

Consider this: global growth is more evident, with the US firmly on track for a 2.8% growth rate this year; the eurozone is slowly emerging from its recession; and Chinese authorities have committed to a 7.5% growth rate. Even in developed markets, growth is once again synchronised, which supports the earnings outlook.

Company balance sheets are also very strong, which underpins the quality of the earnings outlook, and also improves the odds of mergers and acquisitions.

And, despite tapering in the US, liquidity is still being pumped into the system — albeit at a slower pace.

Although the Fed rate is expected to be hiked to 1% by the end of 2015, this is unlikely to affect markets, given the expected slow pace of the rate increases and the strength of the US economy.

There is another key reason why a crunch is unlikely.

Historically, major market corrections occur when the yield curve on bonds flattens — in others words, when the yield that investors get on 10-year bonds equals what they’d get by investing in short-dated bonds, like the US two-year bond.

This was the case in 1999 and 2007, years when the market fell 62% and 67% respectively.

Right now, however, there is a 210 basis point gap between the US 10-year bond rate and its two-year bond rate — which means little likelihood of a big correction taking place now.

Even from a technical perspective, the signs are good: the underlying trends in prices are pointing upwards, with the MSCI World Index firmly above its 40-week moving average. The low level of volatility, as reflected in the VIX volatility Index below, supports the risk appetite of investors.

Of course, it is true that valuations are the biggest concern. The MSCI World index, for example, is now trading on a price:earnings ratio of 17.5, which is above its historical price:earnings level, while the S&P index and the JSE’s All Share index are on price:earning ratios of just over 17.

Although these valuations are high, when you take into account the forward earnings for companies, these ratios look less demanding, falling to 16 and 14 respectively.

So, even though valuations might seem high, they are not in bubble territory — and stockpicking opportunities are there.

Looked at from another metric, price-to-book measures are also nowhere near bubble levels. Investor euphoria that typically occurs at a market peak is also absent.

Taken all together, the evidence suggests the stock market is not in a bubble or grinding towards a bear market.

True stock market bubbles, after all, are not that common, and generally only occur every 30 years or so.

Specifically, US stocks saw major tops in 1901, 1929, 1964, 2000 and 2007. Of course, you can hardly blame policymakers for remaining cautious, given the economic and emotional scars left by the last two big corrections, in 2000 and 2007.

Maritz is CIO at Southern Charter