The bull market for U.S. equities is now five years old. Happy birthday!
It seems like only yesterday that the S&P 500® Index-ended its relentless downward spiral at the curious level of 666. Related markets, such as emerging markets and high-yield bonds, had already put in their lows in December 2008, but U.S. equities kept on going down until March, when the S&P 500 finally put in a technically perfect low. A generational bottom if ever there was one.
And here we are, five years later and 182% higher on the S&P 500®. So let’s do a quick recap of where we were then and where we are now.
Then and now
In March 2009, the S&P 500 bottomed at 666. The consensus earnings estimate at the time was $66 a share, and the forward price/earnings (P/E) ratio had briefly dipped below 10x on an intra-day basis. Three-month Treasury bills were yielding 0.19%, and 10-year Treasury bills were yielding 2.87%. The Federal Reserve System Open Market Account (SOMA) stood at $584 billion. Spot gold was $939, the dollar index was 88.6, copper was $1.70, and Brent crude oil was $34.48. The spread on high-yield domestic corporates was a whopping 1,650 basis points (bps).
Fast-forward five years. The S&P 500 stands at 1,800 or so in early March. That’s an annualized return of 23% for the five year period—thank you very much. Consensus earnings are now at $120 a share for a mean forward P/E ratio of 15.6x. Three-month bills are yielding 0.05% and 10-year bills are yieldings 2.8%. The Fed’s SOMA now stands at around $4 trillion, thanks to four years of quantitative easing (QE). Spot gold is $1,338 after having reached a high of $1,910 in 2011. The dollar index is around 80, copper is at $3.10, and Brent crude oil is at $109. High-yield spreads are 418 bps.
So there you have it. Interest rates are pretty much where they were five years ago, but the Fed’s balance sheet, the stock market, and commodities are substantially higher, and most economic indicators are in much better shape.
An unusual period
So, how unusual have the past five years been compared with the market’s “normal” history? Very. The chart below shows historical risk and returns for the major asset classes from January 2007 through February 2014. Risk, as measured by annualized volatility, is on the horizontal axis, and annualized return is on the vertical axis. The size of each dot measures the risk-adjusted return—how much return you get for each unit of risk. The horizontal lines are the respective inflation rates for the two periods—2.0% since March 2009 and 4.2% since January 1970. As you can see, the risk levels are about the same, but the returns since March 2009 are vastly higher, resulting in much higher risk-adjusted returns.
The question, of course, is, "How much longer can this go on?" The good news is that the odds that the U.S. economy will go into recession in any given year have gone from one in two before the Great Depression to one in four during the 1960s, 1970s, and 1980s, to one in seven since then. This suggests that even after a five-year recovery, we are (statistically, at least) not yet due for a recession or bear market.
Moreover, if the U.S. stock market has indeed entered a secular bull market (read Fidelity Viewpoints®: "Three 2014 stock market scenarios)," the outsized 23% annual return since the 2009 low could actually be par for the course for years to come. After all, since 1900, the annualized return during secular bull markets has been 18%, compared with the long-term average return of 8%, and the secular bear market average of only 1%. And secular bull markets have on average lasted 21 years. That suggests that the last five years could be only the beginning.
Wall of worry
There are always things to worry about, however, which is why it's "called climbing the wall of worry." The recent string of weak economic data is likely weather-related, but it still casts a shadow on the notion that the U.S. economy has finally reached escape velocity (i.e., sustained higher growth) and that the Fed can finally taper QE. I still wonder whether there will be unintended consequences from QE. I find it hard to imagine that the Fed can add $4 trillion to its balance sheet without there being some sort of price to pay for it.
China just had its first corporate bond default, raising questions about whether China’s credit cycle—some say bubble—has finally peaked. This plays into the emerging-market story, which has been front and center this year. Emerging markets are stuck in a vicious cycle of deteriorating current account balances, as China imports less from other emerging market countries, and those same emerging market countries import more as a result of domestic credit booms facilitated by years of easy money. These worsening deficits can lead to capital flight, which can lead to weakening currencies, which forces central banks to raise rates, which slows down those economies and raises inflationary pressures. And so on.
Back in the United States, we have the stark fact that last year’s 32% return for the S&P 500® Index was produced on an earnings gain of only 5%, leaving the market with little margin for bad news as we head deeper into 2014.
As I have said before, from my vantage point it wouldn’t surprise me to see the U.S. stock market stay in a trading range for a few months so that earnings growth can catch up to prices, thus allowing P/Es ratios to come down a bit. With the U.S. economy firmly in midcycle, that would be a healthy way to consolidate last year’s gain before stocks take off on their next run higher.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
Investing involves risk, including risk of loss.
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