An exogenous shock from Covid-19 triggered the swiftest bear market in stock market history. To investors surprise, markets have recovered from their March 23 lows to be within spitting distance of all time highs again, Fisher Investments believes this fall has behaved more like a market correction (a short fall which is usually over within a few months) than a bear market, and in my view this seems to be a short-term interruption to a secular bull market.
Relatively cheap
Since March 2009, when markets began their long and painful climb, commentators and investors alike have denounced and hated every second of this bull market. Even the mini bear market this year has proven to be a short-term interruption to its relentless march upwards.
A key cause of their anxiety is high valuations, and many commentators fret over high equity valuations, using high P/E and CAPE ratios as reasons to reduce stock exposure. But stocks continue to climb the ‘wall of worry’ confounding their expectations. The mistake they make is only looking at equities relative to their own history, which on this basis do look expensive. But investing is a relative game, where the attractiveness of alternative asset classes are a key driver of equity returns. And since the great recession and Covid-19, the game has changed substantially. Monetary authorities have cuts rates to zero and engaged in unprecedented bouts of QE, depressing yields on government and corporate debt.
Today, yields on 10 year government debt sits below 1%, an instant access savings will give you less than 1% and returns on corporate bonds are at their lowest point in history. Relative to these choices, equities look cheap. And you can also argue that while stocks are expensive in absolute terms, the accommodative monetary backdrop and clear signals of low rates for some time to come; means that higher valuations are likely to be the new normal.
No better alternative
No other asset class has come close to matching stocks’ 10% annualized returns since the beginning of the 20th century. By comparison bonds have returned 4.9%, and bills 3.7% since 1900, according to Credit Suisse ‘Global Investment Returns Yearbook’. Even gold, which unusually has its own fan club has unperformed equities since the great depression, commodities too, while also producing higher volatility.
What’s key is the recognition that average equity returns (10% per annum for the S&P 500) include both bull and bear markets, therefore the greatest returns occur during bull markets, and in particular during the latter stages of a bull market. As a result, selling too early means failing to capture these crucial returns.
Negative Sentiment – a bullish indicator
Legendary investor John Templeton famously said that “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” After perusing through countless headlines, worries about high valuations, over-reached central banks, spiraling debt etc are ubiquitous – therefore it’s hard to argue that we’re anywhere to close to the euphoric sentiment that characterizes market tops. Moreover, lofty expectations, an absence of fear and late stage investors entering the market in the fabled belief that “this time is different” are other signs that signal market peaks, of which there are little signs of at present. Covid-19 has moved from an ‘unknown unknown’ to a ‘known unknown’, as the market is a discounter of all well-known information, the longer the Coronavirus lingers, its ability to impact the market will diminish. Since the market is a forward looking data processing machine, all known worries including a second wave have been priced in accordingly, reducing its ability to shock markets.
Misplaced fears
There are a bevy of factors touted as reasons to end this bull market, few stand up to scrutiny, I’ve decided to take a look at three of the most common ones. First are concerns over high P/E ratios, which are ubiquitous and these were widespread even before the Covid-19 induced downturn. Fisher Investments highlight that in the 146 years through 2019, trailing P/E’s have told us nothing about where stocks will be one, two, three or five years later. In other words, it is a terrible timing tool. And as explained above, equities are actually attractive on a relative basis.
Elsewhere, fears over high debt to GDP are misplaced, as debt to GDP tells us nothing about a countries ability to pay it. Instead comparing interest payments to tax revenues is a more accurate measure, and the costs of servicing and issuing new debt remain at historic lows. Urban Carmel wrote a fantastic piece about debt and why now is not the time to freak out about it, while this article was written before the pandemic; it is even more relevant today.
Finally, a weak global economy is held up as another reason for a bull market that has no legs. Again, veteran investors will have heard numerous times that the stock market is not the economy. There is no reliable relationship between GDP and the market over a 1-year period and even over a 10-year rolling period. The two have a habit of parting ways and for long periods, see here.
In addition to this, it is worth noting that the technology sector makes up about 25% of the S&P 500, many of which are largely insulated from the pandemic induced shutdown, and others such as Amazon and Netflix are actually benefiting. The skewed nature of stock markets means that a minority of companies have always generated the lion share of returns, therefore it is not unreasonable to see technology companies with the financial wherewithal continue to grow and drive stock markets higher.
All told, worry forms the building blocks of every bull market, and with old worries and new ones abound, I believe this bull market has much further to go.
The Astute Investor 