August 23, 2018
“I knew the record would stand until it was broken.” —Yogi Berra
They say records were made to be broken. By one measure, on Aug. 22nd the Dow Jones Industrial Average surpassed the record set during the dot-com era for the longest bull market without a 20% correction. The journey for this record began from the oversold depths of the financial crisis on March 9, 2009, when the Dow closed at 6,547. In this edition of Market Spotlight we provide some context around the “record” while focusing on themes to navigate this late stage bull.
Milestones Aren’t Headstones
Throughout 2018 many reports have anticipated the Dow breaking the “longest bull” milestone with several reading like a headstone offering “born on” and “died on” dates of when the bull market began and when it ended. But it’s not over. Frankly, there are too many opinions around the longest bull topic to reach an industry consensus agreement. For example:
- The S&P 500 has had longer bull runs than the current Dow streak.
- Some calculate longevity records based on closing market prices whereas others use intraday price changes to stretch for records.
- Others determine bull and bear markets only by hindsight once market peaks and troughs have already occurred. For example, since we have not yet recovered the Jan. 26, 2018, record high we have not proven the decline is over.
- Some use trading days while others use calendar days. Before 1952 markets also traded on Saturdays.
Takeaway: For purposes of this report we stipulate that since the March 9, 2009, bottom, the Dow has not dropped by more than 20% marking the longest period on record without a 20% drawdown. March 9, 2009, is a widely agreed upon “born on” date; however, a “died on date” has yet to be stamped on a headstone as the bull market seems poised to advance.
Bear Markets and Recessions Coincide:
It’s natural in later stages of a bull market for investors to ask: “When will it end?” Conventional wisdom that considers only valuation measures (PE ratios) or technical indicators have an unreliable track record predicting bear markets, but this is where investor mistakes are often made by taking money out of the stock market prematurely. Cheap markets can stay cheap, and expensive markets can get even more expensive. Overbought and oversold markets can stay that way, for a while.
The truth is bull markets have an optimistic “default” condition as economies, earnings and share prices typically transition through various stages of the growth cycle. This is illustrated in the chart below that shows S&P 500 performance as backdrop for a history of recessions and bear markets. The “white space” indicates where the economy, earnings and stocks prices are growing at some level. Now consider the areas shaded grey (recessions) or red (bear markets).
Recessions and bear markets nearly always occur together with bear markets as a leading indicator for recessions. No signal is perfect and there have been some false signals:
- 1980 recession occurred without a bear market
- Black Monday (Oct. 19, 1987), Long Term Capital Management (1998) and the S&P downgrade of U.S. debt (2011) were all unforeseen events leading to large non-recession drawdowns
While there is no silver bullet to perfectly predict recessions or bear markets, a recent report done by BCA Research offers a simple indicator with historic reliability for signaling the seven recessions we’ve seen over the last 50 years. The indicator combines three distinct factors:
- Inverted Yield Curves: When the 3-month Treasury yield exceeds the 10-year Treasury yield, recessions have on average occurred 12 months later with one false positive signal in 1995.
- Leading Economic Indicators: When the LEI Index declines on a year-over-year basis recessions have occurred on average within seven months.
- Fed Policy: When the Fed Funds rate is deemed to be higher than its equilibrium rate, recessions have occurred on average within 13 months.
When all three flash a simultaneous warning signal, recessions have, on average, begun within six months. Currently, none of the three signals is signaling caution. The yield curve is positively sloping not inverted. The Conference Board LEI Indicator last week set an all-time high signaling optimism. Despite several Fed rate increases, Fed policy is tighter but by no means tight with a negative real Fed Funds rate.
Takeaway: Recessions typically occur after bear markets have begun and often coincide with one another. Neither markets nor economic indicators are currently flashing a recession warning sign. Reliable economic indicators can help investors proactively reduce their risk exposure during periods of economic contraction and market volatility; however, no indicator is full proof.
Midterm Election History:
Throughout the year we have discussed the upcoming midterm elections and assumed rhetoric from both sides of the aisle will heat up after Congress’ summer recess ends. We expect tight races, flipped seats and perhaps a surprise or two based on volatile midterm voter turnout. The chart below offers a post-WWII snapshot for each midterm election since 1946 showing the presence of recession, corrections, returns and seats gained or lost by the President’s party.
We will cover this subject in greater detail as the elections approach with an apolitical eye that only considers anticipated economic and market impact.
Takeaway: In the last 18 midterm elections since 1946:
- Market returns for midterm election years are the lowest of the four-year Presidential cycle
- Corrections have clustered toward the midnegative teens regardless of recessions
- House seats have averaged a loss of 22 for the Presidents party (Democrats need 23 to win the House)
- Senate seats have been a modest negative (Republicans currently have just a one seat advantage)
- Only Clinton and Bush II have gained House seats (as did both Roosevelts before them)
A Real Lesson in Endurance
To be sure, this bull market may be old by historic standards, but that doesn’t mean it is over. Just ask Katherine Beiers. This year Katherine, 85, completed her 14th Boston Marathon and is the oldest woman to ever complete that race. Reports say she prepares by running 45 miles a week and after the 2017 Boston Marathon she left within days to successfully hike the 489-mile Camino de Santiago pilgrimage trail in Spain. Her race times have slowed but, according to reports, she still enjoys cooling down after each race with her recovery drink of choice, a cold beer. One of her postrace interviews concluded with her saying, “Life is good.”
The lesson here is that investing is a marathon, not a sprint. Successful investing requires the same kind of discipline, patience and preparation as running a marathon. For now, current conditions support further advances for U.S. stocks with potential bouts of volatility as 2019 approaches. We expect the recent pace of economic and earnings growth to grind slowly lower as the positive effects of fiscal stimulus slowly become offset by the Fed’s continued pace of measured tightening. We will continue to provide updates as the economic expansion advances and market conditions change. Please contact your Portfolio Manager or Wealth Advisor with any questions specific to your goals or strategy.
Sources: Strategas Research Partners, Evercore ISI, FactSet, Goldman Sachs Global Investment Research, Morningstar, Standard & Poors, Ned Davis Research
This piece is produced by BB&T’s Wealth Portfolio Management Team.
The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.