BY: Jim McElroy
Bull Market or Just Bull
If a bull market can be defined as one which has increased 20% from a previous low, then the S&P 500 entered bull market territory on June 8, 2023, after a bear market low on October 12, 2022. Counting October 12 as the beginning, we have been in a bull market for over eight months. This is the twenty-third bull market since 1928, a series that has averaged 2.8 years in duration (maximum of 12 years and minimum of 3 months) and 133% in price appreciation (maximum of 582% and minimum of 21%). A common characteristic of many bull markets (and bear markets too, for that matter) is that they generally catch almost everyone by surprise. They seem to occur during periods of high pessimism when spooked investors prefer to hold high levels of cash as insurance against expected price collapses. And, as is currently the case, investors double down by taking short positions in supposedly overbought securities. When good news occurs, or the worst expectations fail to materialize, cash and the covering of shorts serve as fuel for stock market rallies. In earlier days, we used to refer to this seemingly inexplicable optimism in the face of pessimism as “climbing a wall of worry”. The current bull market certainly faces a steep and worrisome wall.
Since February of last year, the Federal Reserve, as well as other central banks, has been battling post-pandemic inflation. The relaxation of Covid-19 restrictions and the accelerant of government stimulus (about $3 trillion), combined with shutdown related supply shortages, delivered an almost perfect setting for runaway inflation. Newly empowered consumer demand and a constrained supply of goods and services drove CPI annual inflation from less than 2% in February 2021 to about 9% in June 2022. Despite recent signs of disinflation — the latest CPI report (May 2023) shows a decline to 4.1% for the trailing twelve months — 4.1% is still too high for the Federal Reserve’s 2% comfort level. Beginning in March of last year, the Fed has raised its target rate ten consecutive times, from near zero to a range of 5% to 5.25%. At its latest meeting in June, it paused, but gave every indication that tightening would likely continue. Many market pundits opine that there will be two more .25% increases before the end of 2023. More than that may not be a feature of current stock market valuations.
As we’ve often remarked, the Fed’s history of taming inflation by raising rates without incurring a recession is not good. The tactic worked when the Fed was preemptive in its efforts and began raising rates while inflation was still below 4% (e.g., early 1994). But when inflation has risen well above 4%, it’s very difficult to slow the economy enough to reduce inflation to acceptable levels and still maintain positive growth. Timing is everything. As former Fed Chairman William McChesney Martin put it, the Fed should “remove the punchbowl” before the party gets out of hand. Today’s situation has partygoers swinging from the chandeliers and headed for a hangover. It’s still possible that the Fed, with an abundance of skill and luck, can engineer a soft landing — less than 2% inflation and no recession — but we are skeptical.
On the positive side, however, not all recessions have been immediately preceded or accompanied by bear markets. Over the last seventy-five years, there have been twelve recessions and thirteen bear markets: at least four of these recessions occurred without a related bear market, either immediately before or during the event. If, as we believe, the odds strongly favor the Fed crossing over the tipping point and pushing the economy into a recession, then the message from the current bull market is that the next recession need not be very deep, very painful or very imminent. An alternative explanation that the market believes the Fed is capable of managing a soft landing, seems to us unlikely. The questions that the current bull poses are how far away the next recession is and how destructive it will be.
So far, the economy is holding up rather well in the face of Fed tightening. Some — the Fed, for example — might say too well. GDP in the first quarter of this year was a positive 1.3% (annualized); estimates for the second quarter are for a 1.8% increase. The unemployment rate in May was at 3.7%, higher than April’s 3.4%, but still at the low end of the series’ fifty-year history. The annual increase in average hourly earnings of employees in March (latest reading) of 4.3%, though declining from a peak increase of almost 6% a year ago, is still above the fifty-year average. Disposable personal income after inflation was up 2.1% in the first quarter, and consumer expenditures in April (latest year-over-year number) were up 2.3%, comparable to pre-pandemic levels. All this follows the most aggressive Fed tightening — ten increases from near zero to 5% over 17 months — in at least 30 years. The data for the next few months may clarify the Fed’s intentions on rate hikes — continue to pause at 5% to 5.25%, resume incremental increases at .25% or accelerate to more aggressive tightening — but for now, we see no reason to expect the Fed to cut rates. As we mentioned above, the consensus opinion is for two .25% increases before year-end.
We opened this piece by humorously questioning whether the current bull market is legitimate. It is legitimate for the S&P 500, but we should mention that the bull market is not evenly spread among the constituents of that index: most of its return comes from six very large-cap stocks (Nvidia, Microsoft, Alphabet, Apple, Amazon and Meta) that happen to be part of the buzz associated with artificial intelligence. The equal weighted S&P 500 has yet to cross the 20% threshold and is up only 15.6% from its previous low. The same is true of the Dow: but up a somewhat better 16.4%. Nevertheless, stocks are up, in spite of the Fed’s actions and threats.
We are wary of second-guessing the market: if the evidence, as we see it, doesn’t support the current semi-ebullient market, then perhaps we don’t see all the evidence. A tightening Fed, an inverted yield curve, a 20 P/E multiple on expected earnings (25% higher than the thirty-year average of 16), an absence of breadth in the components of the stock market … all are clear indicators of an extended market. For these reasons, we recommend caution. But because the market often sees or foresees things that we do not, we are reluctant to move beyond a neutral stance in equities. To the extent that equities have appreciated beyond the neutral weightings specified in portfolio objectives, we have been re-allocating to underweighted asset classes, most likely to fixed income or cash equivalents.
Not Investment Advice or an Offer
This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.
