By Juliet Ellis
We believe that five years from now we will look back and see that we were in the early stages of a secular bull market - defined as the S&P 500 Index rising 8% to 14% annualized with only short intervening declines. Sales and earnings growth of 4% to 6%, combined with price-to-earnings (P/E) multiple expansion adding 2% to 5% and dividends contributing 2% to 3% to total returns, could create an environment similar to previous secular bull markets. We see many positive secular and cyclical growth themes in the current market that may help us get there.
Similarities to past secular bull markets
The current market has many parallels to the secular bull markets from 1942 to 1966 and from 1982 to 2000. All three periods followed a period of weakness in the US economy -the Great Depression, stagflation and the Great Recession - and an economic boom cycle occurred during each period:
- 1940s to 1960s. Housing and suburban development, autos and interstate highway construction, jet air travel and airport development, television and modern advertising, and the introduction of air conditioning to the Sun Belt states.
- 1980s and 1990s. The rise of technology, personal computers, cell phones, fax machines, laptops and the Internet.
- 2011 to present. The housing and consumer durable spending recoveries and the US manufacturing renaissance led by the shale energy revolution and need for energy infrastructure.
With the Federal Reserve (Fed) winding down quantitative easing (QE) and potentially raising interest rates in 2015, many investors assume rising rates will negatively impact equity market valuations. But in reality, the historical relationship between equity market valuations and the 10-year yield illustrates that the 10-year yield can rise from current levels (2.16% on Dec. 10, 2014) up to 4.5%, with P/E multiples rising from 15x up to 25x, before P/Es begin to contract as the 10-year yield moves above 4.5%.1
Another common misperception is that a strong dollar is bad for US equity markets. Our research shows that during periods of rising dollar strength, the market has risen by an average of 14.4%.2
Some investors also think that corporate profit margins have peaked and will decline. We've observed that margins tend to peak following an inverted yield curve at the beginning of recession and following declines in capacity utilization. We believe capacity utilization will continue to rise, and the economy will continue to expand.
We see opportunity in two types of US growth:
- Long-term secular growth. This includes biotechnology innovation, new mobility product cycles, on-demand digital content, market share shifts to e-commerce and social media advertising, and demographic shifts as baby boomers retire and echo boomers begin to earn and spend.
- Near-term cyclical growth. This includes capital expenditure cycles for petrochemical plant expansion and non-residential construction; the housing recovery and ripple effect of consumer durable spending; the development, production, transportation and processing of shale oil and natural gas; and the commercial aerospace cycle.
What are the risks?
Several risks could negatively impact our secular bull market thesis.
- The Fed tightening monetary policy too much too fast could derail growth.
- Deflation is a bigger risk than inflation, in our view, and could send the economy back into recession.
- Although profit margin compression could negatively affect our earnings growth assumptions, we believe it's unlikely due to structural shifts in productivity.
- Echo boomer unemployment could adversely impact consumer spending and gross domestic product growth.
- An oil price shock could create a headwind for consumer spending.
1 Sources: Royal Bank of Canada, Federal Reserve and Macrobond, December 2014
2 Sources: Bloomberg L.P. and Invesco Quantitative Group. Data from March 31, 1967, to Nov. 11, 2014.
A stock's price-to-earnings multiple (also known as its price-to-earnings ratio) measures its valuation. It divides a stock's current share price by its earnings per share. When a multiple expands, it means that number increases.
The Great Recession refers to the recession that lasted from December 2007 to June 2009.
Echo boomers are the children of the baby boomers.
The S&P 500 Index is an unmanaged index considered representative of the US stock market.
Common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer's board of directors and the amount of any dividend may vary over time.
Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.
Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources. Short-term fluctuations in energy prices may cause price fluctuations in an energy fund's shares.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
Investments in the aerospace sector are expected to be closely tied to conditions within that sector and can be more volatile than more diversified investments.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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