We all appreciate that we are currently in a bull market with the S&P 500 (SPY) making new highs once again this week. However, it is prudent to consider what might create a favorable market to be on the lookout for. That's why Steve Reitmeister shares insights on the 2 main causes of bear markets. And what a concern that must be for investors at this time. Read below for more.
A market that refuses to fall…will inevitably rise
And this simple logic is exactly what we see happening at this stage. Even though the start date for the Fed's rate cut starts further, investors just don't want to lose their grip on the stock market.
This helps explain why the S&P 500 (SPY) pushed to new highs once again on Thursday even as Fed officials are singing in unison about the dangers of cutting rates too soon. It must be assumed that this positive price trend will remain in place until there is a dramatically negative catalyst.
So this leads to the question…what could break this bull market?
This will be the focus of today's discussion.
Market Commentary
One of my favorite investment quotes is:
“It's a bull market until proven otherwise”
It means that the natural gravity of the stock market is to move higher. This helps explain why the average bull market lasts 63 months while the average bear market lasts only 13 months. That's a 5 to 1 advantage in favor of being in a bull market.
Or to put it another way…it's harder to create a bear market than most people realize. So you really need some extraordinary events to shake stocks off their bullish axis.
When you boil it down, there are really only 2 ingredients that create a bear market. Let's examine both below.
The first, and most obvious, is the idea of forming a recession. This lowers the earnings outlook and reduces risk taking leading to lower PE per share. This combination culminates in an average market decline of 34% for the S&P 500.
The second reason stems from a stock price bubble bursting (often with a recession following all that loss in household net worth). The two obvious examples are 1929 and the tech bubble of 2000.
Yes, some may point to the Great Recession of 2008. But that was from a real estate bubble that led to bank failures. This is an interesting situation to be sure…but unlike overpriced stocks leading to their eventual downfall.
On the recession front, the economy continues to advance at a healthy pace with GDP now estimated for the first quarter of up to +2.5% growth. This is very close to the long-term average of +2.7% and certainly does not hint at a recession.
True, there is always the concern that the Fed overstays their welcome with high rates that usher in a future recession. This fear comes from 12 of the last 15 rate hike cycles ending in recession. Still, it looks like Powell and company are good students of history and are well on their way to managing a soft landing that allows them to cut rates before a recession unfolds.
I recently saw that the current market PE (20.7) is at 5% of all time. It makes us stop in our tracks and consider whether we are overrated.
The counter argument to this is that investors now have a better understanding of the risk and reward of the stock market versus bonds and cash. This has led to higher PEs for stocks over the past 20-30 years making the long-term historical benchmarks a bit outdated.
As a counterargument, I want to share this chart of the PEG ratio going back 30 years:
The PEG ratio is my favorite valuation metric as it tells you what you are willing to pay for each unit of earnings growth. It means that a tech stock growing earnings 20% per year SHOULD have a higher PE than a sleepy utility company with a paltry 3% earnings growth.
As you can see the current PEG level for the market is somewhat in the middle of the pack for the last three decades and not a cause for alarm on the valuation front.
However, there are certainly groups that are being valued a bit too rich like shares of Magnificent 7 and some of the “trendy” AI companies. Interestingly, Tesla has now finally come down from their very lofty heights with shares 40% higher. I'd like to see some of that profit go to these other names with that money flowing into other worthy companies with more attractive valuations.
Bringing it back to the top, it's a bull market until proven otherwise. And since we just reviewed what could disrupt the market (recession and appreciation), we're on pretty safe ground on that front as well.
So, keep investing fully in stocks. Just keep a bigger eye on value at this time, given that there really are some overpriced stocks that need to fall.
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Steve Reitmeister…but everyone calls me Reity (pronounced “fair”)
CEO, StockNews.com and Editor, Reitmeister Total Return
Shares of SPY were trading at $514.66 per share Friday morning, down $0.15 (-0.03%). Year-to-date, SPY has gained 8.28%, versus a % gain in the benchmark S&P 500 over the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in Reitmeister Total Return Portfolio. Learn more about Reity's background, along with links to his latest articles and stock picks.
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