Stock markets not only survived another September – historically a difficult month for stocks – they added to the already-strong performance of 2017. The S&P 500 gained 2% in September, leaving stocks 4.5% higher for the quarter and with gains of 14% year-to-date. The broad indexes seem impervious to news flow that might otherwise have taken stocks down a notch or two. Performance this strong, this late in the cycle, is not unheard of but it has caused many to question stocks’ ability to push higher from these levels.
This bull market stampede started in 2009, so stocks have been rallying for almost a decade. Those who panicked in ’08-09 and have been sitting on the sidelines are understandably skeptical. Oddly, many investors who begrudgingly stayed invested and have benefited from the tremendous recovery also don’t trust this bull market. These so called “hated rallies” are quite durable because the exuberance that inflates bubbles and marks turning points is simply not the predominant sentiment today.
The strength and longevity of this bull market can be explained by several factors. First, the starting point in 2009 was artificially low – driven to extreme by fear in the markets following the credit meltdown. Second, interest rates have stayed at crisis levels for the duration of the bull market despite the removal of the conditions that necessitated a zero-interest-rate policy in the first place. Third, profits have generally grown proportionate to the increase in stock prices. And lastly, for the first time since 2010 (briefly), all the major economies of the world are growing together in a synchronized global expansion. Whether the bull market can continue and for how long is uncertain. It does have a lot of positives going for it, and an old Wall Street adage says that, “bull markets rarely die of old age.”
We talk about the important distinction between “price” and “valuation,” and it bears repeating again as the fate of this lengthy bull market is debated. It is true that most stock prices have increased significantly since 2009. Therefore, prices are high relative to where they have been. However, that doesn’t necessary mean that stocks are expensive at relatively higher levels – perhaps after even doubling or tripling in the past nine years. If the profits of an underlying company have grown as fast or faster than the company’s stock price has risen, the stock is no more expensive now than at the market’s nadir in 2009. In other words, the increase in price is validated by the superb operating performance of the company. Still not convinced? At the end of 2009, Apple’s valuation (price to earnings or P/E) was 20 times 2009 earnings. The stock price was $30. Today, it trades almost 15% cheaper (17.5 times profits or P/E) despite the stock quintupling to $150 since then.
Despite seemingly solid footing for stocks, there are some things to pay attention to in the coming months. The all-important holiday retail season is upon us, and consumer spending comprises 70% of the domestic economy. Clearly shoppers’ habits are evolving (on-line verses in-store) but overall spending should be strong. The Fed is likely to take another step towards rate normalization later this year, but markets should take this in stride. The economy is expanding (perhaps at an accelerating rate) and doesn’t need excessively accommodative monetary policy. To the extent Congress accomplishes any meaningful tax reform, sanity on the fiscal front relieves some of the Fed’s undue burden to use monetary policy to counteract our ridiculously complex and burdensome tax code. All that said, markets rarely pull back on news that has been part of the collective dialogue for weeks and months. It is usually takes a complete surprise to rattle markets. So, while such a surprise is in no way off the table with the current geopolitical environment, much of the current administration’s volatility and unpredictability has been priced into the current market.