By some measures, the current bull market in US stocks is now the longest in history. The S&P 500 has not experienced a drop of more than 20% since March 9, 2009, more than 10 years ago.
The animation below, put together by Corion Capital, shows how this period compares to the four longest bull markets in the past:
This extended rise in US stocks has also translated into a bull market for global stocks generally. Since the US makes up over 60% of the MSCI World Index, the performance of listed equities in New York has driven overall global returns.
The longevity of this bull market has however caused as much consternation as it has excitement. The longer it carries on, the more worried many investors have become that it must be nearing its end.
For Gerrit Smit, head of equity management at Stonehage Fleming, this is however too simplistic a view.
“There has been a perception for a long time already that world equity markets have run very hard in a very long bull cycle and therefore we may be approaching the end,” says Smit. “For me that is not a very convincing argument on a number of levels.”
The first is that despite the length of the current bull market, it has not delivered the highest return of any previous cycle.
As the Corion Capital animation shows, the scale of the current recovery is beaten by both the ‘roaring 90s’ and the recovery from the Great Depression in the 1930s. The rate at which the market has gone up has therefore been fairly moderate.
“That is a very important point to make,” Smit argues. “Despite the length of the current bull market, we are not dealing with an overheated economy, whether in the US or the world, and on that basic principle, one cannot make a case that it now has to come to an end.”
This, he believes, is particularly the case given the current state of monetary policy around the world.
“I probably have more comfort than some others that this slow growth can carry on for quite a while, because of the low inflation environment we are in,” say Smit. “Everything is less cyclical and therefore you have less risk of the economy overheating due to imbalances that develop.
“It may be that we are in for quite a soft landing, with a long landing strip, rather than a cliff around the corner.”
The valuation question
The second important consideration, Smit believes, is that, on certain metrics, equity markets do not look that expensive. As the chart below shows, viewed on a historical price-to-earnings (PE) ratio and a 12-month forward PE basis, the S&P 500 is currently not stretched by historical standards.
“The S&P 500 PE valuation is very close to its 30-year average,” Smit points out. “So just on that basic principle, one cannot make the case that equities are overvalued.”
Free cash flow yield and dividend yield tell a similar story. As the chart below shows, they are currently very much in line with long term averages.
Not everyone agrees that these are the best metrics for looking at the current market, however. Things look decidedly different if one uses a 10-year cyclically adjusted price-earnings ratio (CAPE or PE10), which divides current prices by average earnings over the past 10 years.
On that basis, the S&P 500 is trading on a multiple of around 30 times, which is much higher than the long term average of 16.9. As the graph below shows, this puts the current market in the 95th percentile historically, only marginally below where it was before the 1929 peak that preceded the Great Depression, and higher than where it was before the Global Financial Crisis.
What is interesting about these competing perspectives is that Smit believes investors are generally more likely to be bearish at the moment than to share his bullish view.
“My impression is that many investors have been uncertain and sceptical for quite a while, and many are underinvested rather than overinvested,” he says.
This is supported by the chart below, which shows market sentiment as measured by the American Association of Individual Investors (AAII). It is currently below average – which means more investors are bearish than bullish – and has been for most of the past year, and even most of the last four years.
“The proverbial individual investor is a bit of a contraindicator,” Smit argues. “They are often too optimistic or pessimistic at the wrong time.”
If you agree with Warren Buffett’s dictum that the best time to be greedy is when others are fearful, then perhaps this suggests that now is not a bad time to be buying. Particularly, as Smit points out, because there aren’t many other options.
“The moment we start talking on a relative basis, the argument that you should stay in equities becomes a long stronger,” he says. “They are attractively valued compared to other asset classes, especially because of the low interest rate environment. If we are correct about a continuing environment of moderate growth, that will keep us in equities.”