Can the ageing bull market survive 2015 and beyond?

The bull market in US equities is now almost six years old, with stocks having more than tripled since March 2009. Might 2015 prove to be the year that finally ends the advance, or can the bulls continue to prove the doubters wrong?

Despite stocks’ troubled start to 2015, there’s little to suggest any serious diminution in momentum. The S&P 500 hit all-time highs on 53 occasions in 2014, the most in a single year since 1995. The index got through the year without once suffering three consecutive daily declines. Volatility continues to diminish, with 2014 levels roughly half that recorded in 2009.

Still, sceptics say a serious decline is matter of time. The bull market is getting long in the tooth, they say; this is the fourth-longest rally in history, as well as the fourth-strongest in terms of percentage gains. Valuations, too, look frothy; the S&P 500’s cyclically adjusted price-earnings ratio (Cape), which averages earnings over a 10-year period, is now above 27. That’s almost 70 per cent above its long-term average, and at levels only exceeded on three occasions - at the major market tops in 1929, 2000 and 2007.

That sounds damning, but bulls argue Cape has outlived its usefulness, having signalled a market over-valuation for most of the last 25 years. According to JPMorgan’s latest Guide to the Markets report, Cape has averaged 25.3 over the last quarter-century, barely below current levels. The same report notes stocks trade on a forward price-earnings ratio of 16.4, only slightly above their 25-year average.

Other valuation metrics, such as the index’s price-book ratio, are also in line with the 25-year average.

Duration

As for duration, the current rally may be longer and stronger than average, but that doesn’t mean it must end any time soon. The longest uninterrupted bull market in history, between 1987 and 2000, lasted for 13 years, more than twice as long as the current rally. Stocks advanced by 582 per cent during that time, almost three times more than the current bull market.

Additionally, note that US stocks fell by 19.4 per cent in 2011, just shy of bear market territory (a 20 per cent decline). If one dates the current bull market to 2011, then the rally looks nowhere nearly as aged.

Ultimately, the data gives ammunition to both bulls and bears. For example, research by S&P Capital IQ analyst Sam Stovall indicates the average bull market spends around 7 per cent of its time at new highs. The S&P 500 has hit new highs on 98 occasions since 2009, which accounts for some 7 per cent of trading days.

So is it time to run for the hills? Not so fast. During secular bull markets, such as that seen between 1982 and 2000, it’s estimated markets spend about 9 per cent of the time at all-time highs. If the bull run is merely a cyclical advance during a longer-term secular bear market, new highs are much more rare, occurring on roughly 4 per cent of occasions.

Secular bull or bear?

In other words, the key to assessing the health of the current bull market is to assess whether we are in a secular bull market or a secular bear market.

Stocks were in a secular bear market between 1930 and 1950 and again between 1965 and 1982, enjoying numerous cyclical advances but ultimately going nowhere. By 1982, stocks were cheap and unloved, paving the way for a secular bull market that topped out in 2000, when stocks hit unprecedented valuations.

The question now is whether the secular bear market that began in 2000 ended in 2009, or whether the current bull market is merely a cyclical advance during a period of secular stagnation.

Unsurprisingly, the extremely strong gains of recent years have led to an increasing army of strategists arguing the case for a secular bull market. Money manager Barry Ritholtz, a well-known bear for most of the noughties, turned bullish in 2009 whilst cautioning that any advance was likely to be cyclical rather than secular in nature. Last August, however, he said he had "slowly been inching" towards the secular bull camp over the past year, and that position is an increasingly mainstream one, judging by recent assessments from Morgan Stanley, Charles Schwab, RBC Capital Markets, and others.

Even Ed Easterling of Crestmont Research, a bearish observer who has written much on the concept of secular cycles, admits the current bull market "is longer and has gone farther than any previous cyclical bull inside a secular bear".

Not settled

Nevertheless, the debate has not yet been settled, and bears argue continued stock market highs do not necessarily mean we are in a secular bull market. In 2007, for example, the Dow Jones Industrial Average traded almost 20 per cent above its 2000 high, resulting in the greatest sucker rally in history, as iconic British investor

Jeremy Grantham

put it.

Similarly, Easterling has pointed out that strong gains are not uncommon in periods of long-term stagnation, with stocks advancing in nearly half of all the years within secular bear markets.

Others argue that if the secular bear market ended in 2009, it will have been much shorter than previous cycles. For most of the 2000-09 period, they add, stocks appeared relatively expensive, excepting a handful of months in late 2008 and early 2009. Typically, low valuations persist for years during secular bear markets.

Some sceptics also suggest that secular bear markets typically end at valuations even lower than those seen in March 2009, although this may be beside the point. After all, the 2009 lows did result in valuations not seen in decades, while sentiment surveys revealed unprecedented pessimism – exactly what one expects to see at generational market bottoms.

Indeed, only truly hard-core bears, such as Societe Generale's Albert Edwards, expect the 2009 lows to be revisited. More typically, those in the secular bear camp suggest investors brace for declines in the region of 25 to 30 per cent, which would bring the S&P 500 back to levels first seen in 2000.

They argue that if we are truly in a secular bull market, strong gains are likely over the next decade, despite the fact various valuation metrics suggest US stocks are already "hideously expensive", as GMO's James Montier recently warned.

Uncertain

Ultimately, investors may be better off sitting on the secular fence, so to speak. Valuation concerns mean there must be doubts over the case for a long-term secular bull market, but equally, market action over recent years must surely give even the most ardent of bears pause for thought.

That’s a frustrating conclusion, of course. However, the problem about secular bull and bear markets, as Easterling admitted in 2013, is that they are “hard to define in real time” and are “much more obvious in retrospect”. Alas, that remains the case today.