by Jurrien Timmer, Director, Global Macro, Fidelity Investments
Believe it or not, we may still be in a long-term bull market.
Key takeaways
- Despite the recent market volatility and geopolitical uncertainty, there is reason to believe the US remains in a long-term bull market.
- However, it appears the market may be undergoing a shift from accelerating to decelerating returns, from growth to value, and from stocks to real assets.
- The current inflation backdrop calls into question whether nominal bonds (i.e., bonds with no inflation protection), will remain good diversifiers to stocks.
- A broadly diversified portfolio may be a strong approach for riding out this bull market's remaining years.
Since 2013, it has been my thesis that the US stock market is in a secular (i.e., long-term) bull market that began in 2009. Secular bull markets are characterized as supercycles—spanning multiple market cycles—with above-average returns. The 2 historical analogs are the supercycles of 1949–1968 and 1982–2000, which both produced about 18% nominal annualized returns over about 18-year time spans.
Using 2009 as a starting point, we are 13 years in so far with an annualized return of 17%. In other words, despite the pandemic and recent geopolitical events, so far we are still following the roadmap of those previous secular bull markets. If we continue to follow that track, there could even be the potential for the market to roughly double by 2027. Seems hard to believe, but we could have said that at any point along the way for this bull market.
In my view, the secular-bull-market thesis can be summed up as a combination of demographics, interest rates, and financial engineering. Interest rates have been in a powerful long-term decline since the early 1980s. That decline coincided with (and perhaps was even caused by) an aging population, which led to slowing labor-force growth. Demographics is destiny, and that certainly rings true for rates.
With interest rates falling, investors ran out of yield in the bond market and instead began to search for income in the stock market. They found it mostly in the big growers, which returned a good chunk of their abundant cash flow to shareholders in the form of share buybacks.
Get more Viewpoints
Sign up for our Fidelity Viewpoints® weekly email for our latest insights.
This brings me to the other pillar of my secular-bull-market thesis: financial engineering by publicly traded corporations. Between share buybacks and merger and acquisition activity, US corporations have retired over $17 trillion worth of shares since 2009. That's almost half of the outstanding market capitalization, and far more than the roughly $2.3 trillion increase in supply over the same period, via initial public offerings and follow-on offerings. It's as simple as supply and demand.
The bull market shows its age
But we have likely reached a point of deceleration. As this long-term bull market grows increasingly mature, the rate of change is declining. This is as natural as the sun descending in the afternoon. If you compare the past 13 years against the secular bull markets of 1949–1968 and 1982–2000, we are now at the point along the roadmap where inflation rises and real returns start to flatten out.
Another reason why the trend should decelerate, at least in the intermediate term, is that stock prices have raced so far ahead of earnings, leading to expanding price-earnings (P/E) ratios. Since the March 2020 lows, the S&P 500® index is up about 74% while earnings growth is up only 50%. Even assuming that the earnings estimates for 2022 and 2023 are correct, that would still leave a significant discrepancy.
Given that the Fed is just beginning a rate-hike cycle, not to mention the current geopolitical uncertainty, it seems unlikely that average P/E ratios will increase from here. This suggests that more mean reversion is in order between stock prices and earnings. That could occur with a quick-but-painful price correction, with a period of sideways stock prices, or just a market that continues to advance, but at a much slower pace. In my opinion the latter 2 scenarios are more likely, in line with past Fed hiking cycles (such as 1994).
Running into inflationary headwinds
Comparing again to the historical analogs of 1949–1968 and 1982–2000, we have reached that part of the supercycle when we trade disinflationary tailwinds for inflationary headwinds.
For me the big question is how strong the inflation headwinds are likely to become. Currently, we're experiencing inflation from supply chain disruptions, a tight labor market, and rapidly rising energy costs. But could that be offset to some extent by the long-term disinflationary forces of demographics, debt, digitization, and disruption? For example, while inflation was rampant during the 1970s, labor force growth was also very strong during that period. That's hardly the case today.
If inflation does increase, one big question for investors is what this will do to the correlation between stocks and bonds. Bonds provide the strongest diversification benefits to stock portfolios when they have an inverse, or negative, correlation with stocks (meaning that when stocks fall, bonds gain in price). But history shows that bonds are inversely correlated to stocks only during periods of low inflation.
Potential implications for asset allocation
What does this decelerating long-term trend, combined with near-term headwinds, mean for asset allocation? Based on historical analogs and recent return patterns, it appears that value is looking attractive relative to growth, and real assets (such as commodities) are looking attractive relative to stocks.
Indeed, commodities appear to be in a new secular bull market (by definition, inflation-sensitive assets should do well if we are entering a new inflation regime). The challenge with commodities is that they spend most of their time just earning the inflation rate, but with very high volatility. As a strategic anchor, the value proposition is kind of rough. Energy stocks could be a pure play if you are a structural inflation bull. And gold can be another great inflation hedge, as I recently wrote.
In my view, the main question that remains unanswered is whether bonds will continue to be negatively correlated to equities (and provide the accompanying diversification benefits). So far they are, but this is a question that will profoundly affect the 60% stocks, 40% bonds paradigm.
If you ask me, it may make sense to be less reliant on nominal bonds (i.e., bonds with no inflation protection) as one's main diversifier—though I'm not giving up on them altogether—and to consider a mix of cash, commodities, gold, Treasury Inflation-Protected Securities (TIPS), and potentially other asset classes. Weighing all the evidence, it looks to me like a very broadly diversified portfolio might just carry the day during the sunset years of this secular bull.
Still room to run
The bottom line is that, despite all the uncertainty in the world, the data is not yet giving me reason to throw in the towel on the secular-bull-market thesis.
But I think it's safe to say that on a rate-of-change basis there is a transition underway, from accelerating returns to decelerating returns, from rising P/E ratios to falling P/E ratios, from growth to value, from disinflation to inflation, and from financial assets to real assets.
*****
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
Copyright © Fidelity Investments Canada
