This strong bull market and its underlying economic expansion are on the brink of becoming the 2nd-longest in US history. That fact is based on data for 33 business cycles dating back to 1854.
And there is no sign of it stopping any time soon before it credibly threatens the record-holding bull of the 1990s. That’s because we still have the big, essential tailwinds in place: accelerating GDP and earnings growth, very low interest rates, and low inflation to keep those rates down.
But with the trailing P/E multiple hitting over 22.5 times — S&P 2675 / $118 EPS (as of Q3 2017) = 22.67 — many investors are looking out for the end of the bull market based on valuation alone, as if we are about to soar into some crescendo of irrational exuberance.
Given this pricey picture, it’s a very good time to take a step back and get a read on just how over-valued the market might be.
We all know about the insane valuations of the Nasdaq Tech Bubble of 1999. But, just how far away from an average “fair value” P/E of 15X was the broader market?
While the Nasdaq P/E was much higher, at the end of 1999 the S&P 500 flashed a scary trailing 12-month P/E multiple of over 29X. It had peaked even higher near 31X in July of that year.
For wider context, the last six bull market tops actually all saw the S&P 500 trailing P/E ratio hit an average peak of 30X earnings. I doubt we get that high again after the lessons learned in the two bear markets of the previous decade, but it’s certainly still possible.
Bottom line: Historically speaking, we aren’t even close to a bubbly valuation peak that would have me concerned about the end of the bull market — especially with 2-3% GDP growth, attractive rates, tame inflation and double-digit earnings growth forecasts, which, for the benchmark index, are expected to reach a record $140 EPS, equating to a forward P/E multiple of just 19X.
Continued . . .
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The Life and Death of Bull Markets
Bull markets don’t die of old age, nor do they go out with a whimper. They tend to go out with a bang of euphoria as everybody and their brother are buying stocks with emotional zeal.
The death of bull markets is also strongly correlated with two other events: economic recessions and inverted yield curves. We have little danger of either right now.
What we have on our hands now is a wild bull running after he was penned up for 18 months during the earnings recession of 2015-2016.
And this bull is still driven primarily by technology innovation which infiltrates and ignites all sectors including leading areas like Industrial Products, Healthcare, and Construction.
An area of particular interest for me has been how the government data for GDP, productivity and inflation remain so tame when industries like high-performance cloud computing, mobile communication devices, robotics, materials science, and AI applications are actually accelerating growth significantly.
In fact, it is because of technology innovation and increased efficiency that the corporate returns on invested capital across sectors are boosting productivity in new ways that the government data doesn’t capture, or obscures.
And this keeps inflation at bay, which keeps the Fed “easy” until wages start rising.
Heads Down, Picking Stocks
This economic backdrop is one that equity fund managers can really sink their teeth into. They have already been “heads down, picking stocks” in their favorite industries for several years with long-view, multi-year time horizons, so why would they stop now when global fundamentals are still improving?
And a mature bull market still has a big mission left to accomplish in this environment before he rolls over and dies. In two words, it’s called multiple expansion. This is classic late cycle bull behavior as money keeps pushing into stocks as the only game in town and bonds have lost their safety luster.
Bottom line: The trailing P/E will continue to drift above 22X and the forward P/E will make its way toward 20X. Euphoria is a ways off. Think 20 X $145 (forward 12-month EPS) = S&P 2,900 sometime next year, with an occasional 3% gut check to keep us honest. And this estimate will only rise with beneficial tax reform.
Expanding Economy + No Mania = BTD
Now that we’ve put the market’s current valuation in proper perspective, it’s easy to see why stocks levitated to new highs this year while nervous investors wring their hands about this or that worry, either afraid to buy the new highs or sent scurrying with their profits.
The strategists who don’t make a lot of headlines are still the ones “heads down, picking stocks” as I like to say. They don’t care about the Fed or China or politics. They block out that macro noise as they look out 2 to 3 years and picture the full realization of their investment picks.
This cycle is certainly unique with massive QE and extraordinarily low interest rates for as far as the eye can see. But it’s also unique because of the explosion of exponential technology innovation that is reshaping industries and fueling growth across thousands of companies.
And most money managers, who “have to buy” stocks anyway, are using the playbook of all the bull markets before.
That playbook says when the economy is humming, the Fed is friendly, and multiples are expanding, you need to be fully invested. And for me that means I keep deploying the strategy that has worked for 8+ years: “buy the dip” (BTD) in my favorite stocks with opportune charts and strong earnings momentum, as delivered by the Zacks Rank methodology.
So while some people hold back, nervous that “the end is near,” well-informed investors like you can take advantage of the multitude of profit opportunities that await in the weeks and months ahead.
What to Buy?
As I mentioned above, sectors like Industrial Products, Healthcare, and of course, Technology look particularly strong.
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Kevin, Senior Stock Strategist at Zacks, is a leading expert in technical analysis and what makes markets move. He provides commentary and recommendations for Zacks TAZR.