There Is No Bear There

Stocks have rallied hard this year, logging all-time highs and driving widespread speculation a meaningful downturn—a bear market—lies immediately ahead. Various rationales exist. Some, for example, suggest an overvalued market, high political risk and unfavorable technical indicators will be the culprits. However, in our view, these alleged risk factors lack teeth and are broadly misperceived.

To support the assertion the market is overvalued, many point to slowing earnings growth—claiming profits have “stalled,” and the market thus warrants a below-average valuation instead of today’s slightly above-average levels. To me, 4.7% y/y earnings growth isn’t exactly stalled, but I’ll not quibble with word choice. Rather, the broader issue is earnings growth routinely slows during the middle to later stages of bull markets, while valuations expand. In our view, this isn’t because investors necessarily assign a higher multiple to current earnings. Instead, as sentiment improves, they gain confidence earnings growth, though modest, will likely persist. It’s a sentiment melt-up—pessimists become skeptics, skeptics optimists and so on, until the bull market reaches its typically euphoric peak. Said differently, “double dip” recession fears abate, and investors assign long-term average market valuations to future earnings, resulting in above-average multiples on current profits. Currently, market sentiment appears to be transitioning away from skepticism to early-stage optimism. This likely explains the recent (and nascent) multiple expansion—a trend we believe will persist as the bull market continues to mature.

Another common theme seems to be bears suggesting an ineffective and gridlocked Congress won’t pass meaningful legislation to resolve important issues facing the country (the debt ceiling, government spending, immigration, etc.), likely spooking investors. However, gridlock doesn’t mean nothing gets done—and stocks may in fact be better off with the more contentious issues being waylaid. Contrary to the bears’ argument, history shows active legislative agendas tend to spook investors more, as major legislation often ends up having negative unintended consequences (or its outright intent affects property rights one way or another). It’s this uncertainty investors tend to fret over, as they prefer the visibility of continued status quo to shifting sand—even if the status quo is sub-optimal.

Still, certain issues—namely, the debt ceiling—will require Congress’s attention this autumn. But this historically ineffective legislature—and it’s true, the current Congress has passed the fewest bills at this point in its tenure of any on record—has already increased the debt ceiling once, the 107^th since 1917. In all likelihood, they’ll do it again. The other issues facing Congress this fall, though important, need not be resolved anytime soon for the economic expansion to continue. Fundamentals remain positive (though admittedly not gangbusters strong).

Finally, it seems some bears fret over the length of the current bull market, now longer than the average bull over the last 60 years. Accordingly, they purport the current bull will soon die. Bull markets die for many reasons, but old age isn’t among them. Again, fundamentals support continued bull market and economic growth ahead. Also consider, the average bull market duration is just that—an average. Some are shorter, some longer. The current bull could very well end up being one of the lengthier ones. Investors not participating only because an arbitrary time period has elapsed are likely doing themselves a disservice.

To be clear, there are always potential risk factors to consider. And it’s human nature to be on the lookout for them, since we fear losses more than appreciate gains. But in our view, the big picture suggests the bearish crowd’s warnings are premature.