There are always a million reasons why every market rally is supposed to end, and a million experts (actual and would-be) to explain why.
Valuations are too high, charts augur poorly (whether technical analysis or horoscopes, which quants insist are not the same thing) or we might all be deprived of President Trump’s big, big brain through impeachment, a fate Trump assured us this week would leave us all in the poorhouse.
And yet, here we are, having set record highs this week in the S&P 500 Index SPX, -0.23% if not hitting the record for the Dow Jones Industrial Average DJIA, -0.32% Plus, we’re now in the longest-running bull market ever, by most measures. Whatever is making it happen, it ain’t politics: Markets don’t actually work that way.
And let’s face it: The current Leader of the Free World spent part of Thursday selling the idea that NBC News faked the year-old video where Trump cheerfully confessed that he fired then-FBI director James Comey to stop the investigation of the 2016 election. He has doled out bad investing advice through his infamous Twitter feed for years. And gyrations caused by daily twists and turns of his trade policies have cost investors trillions of dollars.
So if it’s not The Donald, then what is making this bull outlive its many skeptics? Here are some elements of the bull run, with a hat tip to Bill Clinton’s old guru James Carville.
It’s the economy, stupid
Not only is growth strong by recent standards — a 3.2% annual rate in the first half of the year — but inflation is still behaving, with core personal-consumption inflation for the last 12 months still below 2%. And, as The Wall Street Journal’s Nick Timiraos has pointed out, it’s likely to stay that way for the next few months as the anniversaries of months that had higher-than-average inflation last year roil through the calendar.
Lower inflation means less pressure on the Federal Reserve to raise interest rates quickly. Calm interest rates mean that pressure on consumer balance sheets — which are in an historically abnormal state of having both near-record levels of debt and near-record low monthly payment burdens as a percentage of income, thanks to low rates — won’t ratchet up soon. So consumer spending has been growing solidly, and high consumer confidence means it should continue to do so for a while yet.
It’s hard to project macro factors out more than a year or so reliably, so take all this with a grain of salt. It won’t last forever, and in the housing slowdown and consumer debt levels may lie the seeds of the next downturn, especially if the Fed raises rates too fast. But for now, it’s enough to keep the bull market in place. And aside from the corporate tax cut, it was all in place before Trump took office.
It’s earnings, stupid
Profits for the S&P 500 are expected to rise 22% this year, and 10% next year, according to CFRA Research. (The number for this year is bigger because of the corporate tax cut.) Since stocks typically trade on expectations of future earnings, you would expect them to rise when profits spike this much. What you might find surprising is that the relationship is fairly tight right now: The S&P 500 rose 19.4% in 2017, when 2018 profits were the main focus, and is up 8.5% this year, plus dividends.
That means …
It’s valuations, stupid
They’ve stayed fairly modest, though there are always critics. I’ve covered markets off and on for 30 years, and there has always been some money manager ready to tell a Barron’s Roundtable that stocks are disastrously expensive.
The S&P 500 is trading at about 18 times 2018 earnings and 16 times next year’s profits. You can’t argue that these are rock-bottom numbers, but with 10-year Treasury bonds still paying less than 2.9% interest, the arguable P/E on bonds (which obviously are not the same thing as stocks and pose different risks) is above 30.
Earnings underpinning stock prices might come in higher — or lower — than expected. You take your chances, and that’s why some people will pay more for bonds. But over time, stocks have returned more, just as they have through most of this bull market. And an environment where rates are slowly rising, while profits are rising by double digits, is a recipe for more of the same.
Right now, the S&P 500 is within about 100 points of my own year-end forecast of 3,000, which humility requires me to disclose was more a seat-of-the-pants number than the product of a quantitative exercise. But qualitatively, the ingredients for a solid market were in place when I guessed 3,000 in January, and they still are — the economy is solid for another year, while valuations aren’t running out of control.
That’s a winning formula — even if our president is, bless his heart, really stupid.
Providing critical information for the U.S. trading day. Subscribe to MarketWatch's free Need to Know newsletter. Sign up here.
