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What’s next for the longest running bull market?

On March 9, 2009 the S&P 500 Index closed at a post-2008 crisis low of 676.53. More than nine years later, the value of the index has more than quadrupled, and although there is no formal method to measure the duration of stock market rallies, there is a general industry consensus that on August 22, 2018, the current bull market became the longest one in the history of US financial markets.

To put this into context, one ought to remember that the inception of the rally coincided with the US economy just starting to emerge from the abyss of the financial crisis. Soon after, the economy started to grow and this helped to substantiate the move in stock prices. Money continued to flow to the stock market as the Federal Reserve (Fed) adopted ultra-supportive monetary policy in the years that followed.

More recently, the fiscal stimulus in the form of tax cuts enacted by Donald Trump has also provided support to the market. Furthermore, the price dynamics of the stock market as a whole have also been driven by sector-specific developments. Most notably, the technological revolutions attained by the largest technological companies traded in the US market have not only reshaped the digital economy on a worldwide basis, but have also contributed to supporting the performance of the S&P 500 Index.

The pertinent question at this juncture is whether the longest bull market in history is nearing its finale. The now second-longest bull run started late in 1990 and peaked during the first quarter of the year 2000. Within a period of three years, the S&P 500 Index had shed almost half of its value. Anticipating the end of the rally and identifying the point at which further increases in the value of stocks become irrational is crucial for investors.

The best place to start is to look at the state of the economy. The most recent data from the US Bureau of Economic Analysis shows that the economy has grown for nine straight quarters. The unemployment rate is at its lowest in more than 18 years, and according to the Bureau of Labour Statistics, the ratio of unemployed jobseekers per job vacancy stands triflingly at 1.0. At the same time, the Fed’s preferred measure of inflation has been trending upwards since last September, albeit remaining below the stated long-term target for more than six years.

An escalation of the ongoing trade war can cause heightened uncertainty among American exporters

Clearly, the economy is doing well, and there are indicators that it looks set to expand further in the coming months. More specifically, the Conference Board Leading Economic Index for the US, a metric designed to signal changes in future economic trends, has registered a six-month growth rate of 2.7 per cent, with nine out of 10 of its sub-components advancing during the period.

The current economic environment places the policy makers at the Fed in a quandary. Tightening monetary policy too quickly risks bringing the economic expansion to a premature halt, while being more dovish might result in the economy to overheat and inflation to rise.

The Fed has raised policy rates seven times in less than three years. Last October the central bank started to normalise its balance sheet, meaning that some of the proceeds from maturing securities purchased during multiple rounds of quantitative easing are not reinvested, effectively reducing the money supply.

Notwithstanding this, the economy continued to do well. Furthermore, tighter monetary policy does not imply that the policy stance is restrictive.

As a matter of fact, the Fed has recently confirmed that its policy stance is still accommodative. While the unemployment rate is currently lower than the natural rate of unemployment, measures of inflation expectations over multiple horizons remain very close to the Fed’s target. Arguably, this should at the very least enable monetary policy to remain accommodative in the coming months. Based on the current state of the economy and the monetary policy stance, the stock market rally should have room to run further. As always, risks to this outlook are not absent. An escalation of the ongoing trade war can cause heightened uncertainty among American exporters, causing them to delay capital investment until they get a clearer picture of the full implications of any retaliatory actions directed at the US.

In such a scenario with a higher risk of economic slowdown or outright recession, the stock market would in all likelihood lose impetus as investors would seek to shift their asset allocations in favour of less risky asset classes.

Executing a well-timed asset class rotation within a portfolio is no mean feat. Generally, this requires an abundance of skill and experience in navigating financial markets. Nevertheless, when executed properly, shifts in asset allocation can be very lucrative in terms of generating superior portfolio performance.

David Lanzon is a portfolio manager at APS Bank Limited.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. APS Bank Limited is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

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