Has it been eight years since the world emerged from the 2008 Great Financial Crisis that ended (in hindsight) with the S&P 500 (NYSEARCA:SPY) reaching a low of 676.5 on March 9, 2009 before sharply recovering? Since March 9, 2009, the S&P 500 has a 314% cumulative total return (Exhibit 1). From the prior peak on October 9, 2007, the S&P's cumulative total return is 85%. Not bad for buy-and-hold investing despite major hiccups in 2011 and late 2015-early 2016 when the S&P dropped more than 10%.
Exhibit 1 - It's Been A Strong 8-Year Run For The S&P 500
Source: Bloomberg - Chart displays the Total Return Index of the S&P 500
Admittedly, we struck too cautious of a tone in our piece, "Stockpiling Income," published last year against the backdrop of the seven-year anniversary of the bull market. We referenced the Biblical story of Joseph and the period of 7 years of famine that followed 7 years of abundance. We weren't calling for a famine at that time but suggested that it would be prudent for investors to consider 'stockpiling income' in the face of an aging bull market.
When we published the piece, many central banks were in the midst of implementing negative interest rate policies (NIRP) to hold off deflationary forces that were threatening to tip the world back into recession. In addition, U.S. safe-haven debt was yielding next to nothing while investors had bailed on riskier credit such as high-yield and energy master limited partnerships (MLPS) as oil prices had briefly touched ~$25/barrel in mid-February.
Since the 7th-year bull market anniversary (3/9/2016), the S&P 500 has returned 21% while the Barclays Aggregate Bond Index (BNDS) has returned 0.7%. Over the past year, the 10-Year U.S. Treasury yield has risen to 2.6% from 1.9%, but credit spreads have narrowed helping to offset the capital loss from rising yields (assuming you were invested in risky credit).
The Bloomberg Barclays U.S. High Yield spread has dropped to 3.3% from 6.8% back on 3/9/2016. Although Treasury yields are higher versus a year ago, credit spreads are narrower and provide less total return cushion. Hence, expected returns for intermediate, multi-sector fixed income are about what they were last year.
As for equities, on the 7th-year bull market anniversary (3/9/2016), the S&P 500 traded at 16.8x next year's estimate earnings, which seemed expensive during a period when the macro environment seemed less certain than how it is perceived today. Today, the S&P trades nearly 2 points higher at 18.3x next year's estimate earnings. It is important to note that equity markets have tracked earnings over the last 20 years (Exhibit 2).
Earnings anchor equity markets, and apart from the crazy late 1990s' Internet Bubble, rarely do equities disconnect from the earnings picture. If the earnings picture were to falter, either because the current economic cycle finally gives way to recession or proposed fiscal stimulus/regulatory reform do not meet current expectations, then equities may succumb to gravity as earnings would no longer provide substantive support for further advances.
Sure, market volatility may pick up in the face of a tightening Federal Reserve (or the latest machinations coming out of D.C.), but as long as the earnings picture holds up, equities should perform well despite the high valuations.
Exhibit 2 - Earnings Are What Anchor Stock Market Advances
Global markets outside the U.S. do not look as tired or overextended and could benefit from a 'catch-up' should global growth trend higher. Can global markets perform well in the absence of a continued strong run in the U.S. market? The remainder of the year will be largely driven on the timing and success of fiscal initiatives and the extent of monetary tightening (could we see four rate hikes this year?). What if we saw a repeat of 1994 when the Federal Funds Rate rose from 3% to 5.5%?
In that year, the U.S. bond market experienced one of its worst episodes although U.S. equities traded sideways. This scenario could also drive the U.S. dollar higher putting pressure on foreign markets, especially emerging markets that could experience disruptions to short-term lending. Regardless, perhaps we're facing a point where other world markets should take on the leadership mantle from the U.S. (Exhibit 3) if the global economy stabilizes into a new growth cycle.
Exhibit 3 - When Will International Markets Start To Take The Lead Again?
At the time of this writing, 3D Asset Management did not hold any of the ETFs listed in the article. The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy.
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