There has been "one mother of a reflation trade going on here", as Gluskin Sheff's David Rosenberg puts it. After a nasty slide at the start of the year, US stocks have bounced sharply, erasing their losses and regaining record levels. Unlike many other markets around the world, January's China-centred global growth scare didn't send the S&P 500 into a bear market defined as a 20% drop from a previous peak. That means the bull market that began in March 2009 is still intact. This week it became the second-longest on record.
Thursday 28 April marked day 2,607 of this bull run, according to analysts at Bank of America Merrill Lynch. That is one day more than the bull market of June 1949 to August 1956. The longest upswing on record without a 20% fall was the October 1990 to March 2000 run: 3,452 days.
So how much longer can it last? The fundamentals aren't especially encouraging. The US and global recoveries remain relatively lacklustre and first-quarter S&P 500 earnings reports "weren't as bad as anticipated but certainly nothing to write home about", Voya Global Management told Barron's. Around a fifth of companies have reported and earnings are down by about 7% year-on-year.
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Earnings have fallen for the past 12 months. Two of the key causes, the oil price slump and the strong dollar, are reversing. But the state of the global economy and historically high profit margins militate against a significant increase in profits. Indeed, historically stretched profit margins are falling quickly, according to Lu Wang on Bloomberg.com. Net income has declined to 8% of sales from a record 9.7% in 2014. "Rallies have seldom weathered a decline in profitability as violent as this one."
It hardly helps, moreover, that valuations are very high. On a price/book-value basis, the S&P 500 is on 2.8, only a shade below the peak seen in 2007, as John Authers notes in the Financial Times. Similarly, the cyclically adjusted price/earnings ratio is just under 27, close to the 27.5 peak at the top of the credit bubble. The trailing price/earnings ratio is 19.4, the highest figure since 2010. In other words, long-term returns for those buying from here are likely to be lousy.
The uninspiring fundamentals are counterbalanced to some extent by the US Federal Reserve. It is no longer printing money, much of which leaked into asset markets. But it has signalled that it isn't in a hurry to raise interest rates, thus tempering a headwind for equities. But herein lies the main danger for this ageing bull. With signs of a return of inflation mounting, the Fed seems in danger of ending up behind the curve and having to raise rates faster and higher than anyone expects. Beware the inflation scare.
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