Running with the bull: the US equity market’s performance in context

It might surprise you to learn that there aren’t any commonly agreed ways of measuring so-called ‘bull’ markets. Here, we take a look at the different options for interpreting US equity market performance, and explain why we’re not convinced growth in US equities is about to come to an abrupt halt.

1. Taking historical perspective

This method perhaps appears to be the most obvious of the bunch. Looking back across the whole existence of the market, between troughs and peaks, we can identify the length of each rally. We can then compare the current rally to previous rallies and see if it stands out as the longest.

By this approach, the current rally, beginning in 2009, does look the longest. In September, the current rally beat its nearest rival (1990-2000) which was 3,452 days – almost nine and a half years.

However, this metric isn’t perfect. For starters, it can only be used with a considerable amount of hindsight. It takes a year or more to truly establish when a bull run has begun. Even with that amount of backward-looking information, a subjective choice is still required about whether a particular cycle stands alone, or whether it is a ‘short-term’ cycle within a prevailing ‘long-term cycle’. John Authers, journalist for the Financial Times, poured scorn on this type of metric the very day his newspaper gave it front-page billing.

We’re inclined to agree with this view. A more objective assessment of the age of the bull market is warranted. Let’s consider two alternatives.

2. The 20% drawdown rule

There is nothing hard and fast about the 20% rule; it’s taken on a life of its own for sheer lack of an alternative. This rule of thumb has it that the market is considered to be a true ‘bear’ market when a ‘drawdown’ (dip in value) reaches the -20% threshold.  Dips short of this threshold are considered to be just ‘consolidation phases’ – dips in the road on the way through a prevailing bull market.  This convention does, however, allow us to objectively measure the time between successive dips of 20% or more.

Using the 20% rule as a metric of bull market longevity, the current rally has so far been shorter than the one that came to an end in 2000, lasting twelve and a half years. The current rally has clocked up less than 9 years.

But of course, a rule of thumb is just that, and there are plenty of question marks over this particular rule. Namely, it’s not clear why an investor should feel much better about an 18% loss compared to a 20% loss. Nor why a loss of 20% should provide any more information about future financial market conditions than an 18% loss.

The chart below shows, for example, that 20% drawdowns were not an accurate predictor of economic recession (shown as shaded bars). Sometimes a recession did not materialise at all. Sometimes a recession started well before the 20% threshold was triggered.

In all, the 20% drawdown rule is quite arbitrary and not very helpful.

3. The negative-over-a-year-ago rule

Another, and perhaps less arbitrary, rule would be to consider the question:

A one-year period is a reasonable amount of time for a medium-term investor to be interested in.  It’s also a standard timeframe for all kinds of financial and economic analysis.

So, let’s start by saying that if returns are negative compared to a year ago, we’ll call that an ‘event’ so we can analyse these events across time.

The chart below shows the number of years between these events – so the number of years between times when returns were negative compared to the previous year – in yellow.

It shows the current rally to be quite unremarkable on this score. It’s lasted less than two years compared to common periods of three years or more.

Why the US economy could continue to draw bullish sentiment

So, despite all the fuss being made by some commentators about the longevity of the US equity rally, a more sober assessment suggests it’s not about to expire from sheer exhaustion alone.

There are several factors which mean the rally could reasonably continue. The US economy is performing well, and has been accelerating since mid-2016. The global economic recovery took longer to gather pace but, as it continues, will benefit US companies with global operations, including S&P 500 companies.

US economic policy has not yet tightened to the extent that it would “lean against” continued economic growth, and capital market valuation metrics suggest that the stock market is not expensive relative to government bonds.

The Nutmeg view

At Nutmeg, we will continue to monitor global economies, markets and government policies to determine when we think the global equity market begins to look ‘tired’.

One thing’s for certain – our decision won’t be based on the length of time the rally lasts. We believe that’s the wrong lens to use when assessing the situation.  For now, the fundamental investing metrics and principles we use suggest the equity rally looks healthy and with plenty of energy to run, and we’ll maintain our exposure on that basis.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.

Sources

1. John Authers. ‘Authers’ Note: Longest bull**** market’, Financial Times, 23/08/2018
2. The recession periods are set by National Bureau of Economic Research (NBER) and have been obtained via Macrobond