Short and Sharp: The highs and lows of an equity bull market

It is a truth universally acknowledged, that each time the equity market index hits a new record high, investors are filled equally with joy and fear. Joy at the tremendous performance and fear that it is drawing perilously to a close.

This week, the S&P 500 Index pushed through the 2,600 barrier for the first time and, certainly, the equity bull market run has been nothing short of incredible:

  1. The S&P 500 Index has returned more than 350% since the index bottomed in 2009 – the second largest bull market in the post-war period.
  2. It is also the second-longest bull market in the post-war period.
  3. This is now the longest stretch since 1929 that the S&P 500 Index has gone without a correction of 3% or more.

That last point means that it is only sensible to ask: should I continue to ride the equity market wave, or cut my exposure?

I believe the U.S. equity market bull run has further to go. I am encouraged by the signs that U.S. tax reform legislation is likely to pass – but my view is not dependent on its success. I also take reassurance from the fact that economic indicators have been generally positive and that central banks are tightening policy at glacial paces, so they are unlikely to end this economic upturn prematurely.

However, the recent flattening of the Treasury yield curve (the difference between two-year and 30-year Treasury yields) suggests that others may be worried about a coming slowdown. The headlines are certainly alarming – the Treasury yield curve has flattened and has eventually inverted (i.e., long-term yields are lower than short-term yields) before each U.S. recession in the post-war period.

But, then again, the Treasury curve has also inverted nine times since 1960 without being followed by a downturn within two years. The Treasury curve’s forecasting prowess is not much better than that of the typical economist. What’s more, there are other factors that could explain the flattening of the yield curve. These include deflationary pressures from globalization and technology, the fall in the “neutral” long-term interest rate, and the huge amount of liquidity still being provided by global central banks.

Despite my general sanguine feeling about the economy, there are factors that concern me. Namely: I cannot kick the tightness of valuations from my mind, nor a niggling fear that quantitative tightening may not be as smooth as people expect, while geopolitical risk still looms large. Keeping that in mind, I would suggest repositioning into growth regions of the world – my favorite is emerging markets. And if you aren’t worried about the United States, I would consider increasing exposure to U.S small-caps to take advantage of potential tax reform benefits.

I’ll leave you with one last thought. Timing market peaks is notoriously difficult and selling the market too early can be expensive. On average, an investor who sells equities just three months prior to a peak loses around the same amount as an investor who sells three months after the peak… Just consider riding that wave, baby.


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