The typical full market cycle – defined as a bull cycle plus a bear cycle – will last between 4 and 6 years. The one we find ourselves in today is the longest-running bull market in history. It is already 9 years old, and the bear market cycle is still somewhere in front of us. But don’t be fooled. The rules haven’t changed. They never do. And just when you believe things are different this time, the bear will roar.
Why has this one lasted so long? Simple: the economic hole created by the financial crisis was so deep and so structural that it has required years to repair. As a professional banking analyst and money manager during the crisis, I estimated that it would require the banks 6-8 years to rebuild capital and to begin to support the economy in a normal way. The financial authorities did not discuss it and the banks did not report it because to say so would create a panic, but for all practical purposes, the crisis had completely wiped out their capital and then some. It would take years to write-off their bad loans and rebuild capital. The real economy was in equally dire straits. Excessive borrowing by consumers pulled future spending forward and fueled the economic boom that led to the financial crisis. Since then, consumers have been applying income to debt repayment. This created a structural decline in demand and employment.
So why have markets recovered and reached new highs? Simple: global monetary authorities have stimulated growth by reducing short-term interest rates. And when that was not enough, they bought long-term, fixed income securities to drive long-term interest rates lower. The logic? Reduce the interest costs of debt-burdened consumers and businesses to help the healing process. And, perhaps more importantly, drive absolutely everyone out of savings and into risk assets. If consumers will not spend from income, perhaps they will spend from assets.
The good news is, time has passed. The economy has improved. The need for life support has lessened. But, in a market priced for perfection, prices started to fall in late 2018 when monetary authorities began to withdraw stimulus. And of course, the monetary authorities revisited that decision, because no one is entirely sure how strong the underlying economy really is. Indeed, the global economy has been soft for more than a year. Only the US economy has remained resilient to date. But in a global economy, it would be presumptuous to assume the US economy could avoid the flu when all its friends are suffering from it.
This a fancy reminder of the simple fact that a bear will most likely follow every bull. The reason for that bear could be the removal of monetary stimulus as was hinted in the fourth quarter 2018. Or it may very well be caused by something else entirely. It often is. Maybe baby boomers will sell securities to fund their retirement. Maybe the “have-nots” will elect those with more redistributive policies. Maybe there will be global conflict.
We cannot know for certain what will cause it, but we do know that it will happen. Indeed, my conversations with advisors and clients alike acknowledge that it’s unlikely that the markets will continue to appreciate, uninterrupted, for the next ten years. And using history as a guide, current valuations imply 1.00-2.00% average annual returns for equities over the next 5-10 years.* Those returns probably involve a decline and a recovery.
Which brings us back to our role as advisors. What are we doing to temper expectations? What are we doing to prepare for the bear that will almost inevitably follow? Is your investment strategy or your investment manager as adept at managing through bear markets as bull markets? Or will they give the cumulative returns of the last ten years right back, as many did in the last financial crisis? This is a business of compounding, and you can only compound by participating in rising markets and reducing downside capture in falling markets. Failure to do so wastes valuable time horizon. Failure to preserve cumulative returns in the next bear market may leave clients without a sufficient time horizon to start over and rebuild for retirement.
*Pinnacle Advisory Group, Inc, Proprietary Model for Valuation, June, 2019
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The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
The above targets are estimates based on certain assumptions and analysis made by the advisor. There is no guarantee that the estimates will be achieved.
