Markets

Bull Market: One More Year

The current stock market , despite volatility of individual days, seems poised to make a run past old highs. How long can this up cycle last? Maybe about a year, then that's it. Here's why .

European worries (Ukraine, Greece) are getting fresh legs. The latest earnings insight from FactSet researchersshows that year-over-year earnings for the S&P 500 are projected to decline by 4.9% in the first quarter of this year. Growth rates in all 10 sectors are down due to downward revisions to earnings estimates, led by the energy sector. Whatever excuses you hear, weakness in financials is never a good sign.

But look at that boffo February employment number , showing a gain of 295,000 jobs and an unemployment rate lowered to 5.5%, from 5.7%. January's gains, which last month's eclipsed, prompted this Wall Street Journal headline: "Ripe for Liftoff." Aren't we finally about to take off in this recovery?

Lift-off? You've got to be kidding me.

Let's begin with some ironclad facts: The business cycle has never been repealed, and it never will be. Higher levels of employment do not lead to endless levels of expansion in economic activity - a lagging indicator, employment grows for many months after recessions have begun and contracts for many months after the onset of recovery. If higher employment was all that mattered, we would never have had any recessions.

Here are two more maxims, one from Bob Farrell 's famous rules of investing, and one from yours truly. Farrell, the legendary former chief stock strategist at Merrill Lynch, said that there are no new eras , meaning there is always a cycle, and valuations will always revert to the mean.

The second maxim is one you may find surprising - the business cycle does not depend on Federal Reserve interest rate policy. Most investors presume the reverse, but it just ain't so. Monetary policy is a blunt instrument. It can cushion, but it does not protect. The last recession that Fed policy actually engineered was the 1980-1982 downturn, when its chairman then, Paul Volcker, hiked short rates toward 20%. That's how blunt of an instrument it is.

Certainly, the Fed lowers rates in the early stages of recessions, but that has never stopped the economy from going down anyway. As the expansion cycle matures, the Fed then tries to move away from below-normal rates to what it thinks is some kind of normalized level of rates that won't facilitate further speculation.

The '80-'82 episode aside, higher rates don't kill speculation, either - only the collapse of the market cycle does that. Higher rates may cut off one source of alcohol. But believe me, the market knows how to keep getting drunk until it falls over anyway.

What does it all mean for 2015, though - and the current quarter, for that matter? Is it time to retreat, a theme that had a lot of currency during January's darker days, when the Standard & Poor's 500 lost 3.1%. Or is it time to reload and re-enlist for the next big move, what every equity fund manager believes anyway?

Here are some concerns about the bull market's longevity:

One, the market is expensive on just about any numeric metric, though I'm sure some busy Street strategist is hard at work on finding ways that it isn't. The S&P 500's price/earnings ratio stands at 20.19, more than five percentage points above the long-term average.

Two, economic growth has not changed, neither for better nor worse. Since the recession's end, gross domestic product has never grown much more than 2% per calendar year. It was no different in 2014, though corporate profits grew at a slower pace - about 5% overall for the S&P 500, even as the broad index rose more than double that rate.

Three, it's late in the cycle for both the market and economy. Expensive, late-stage markets in low-growth economies may not simply up and die, but they are ill-placed to withstand adversity.

You may wonder why a modest economy should contract, but that's missing the point. There's plenty of excess, it just happens to be concentrated in the 1% economy, the high-income bunch where most of the growth has been. No economic law holds that unemployment has to fall below 5%, once thought to be the floor - that level may well be the limit again this time around.

I don't like the long-term chart of the market, I don't like that we've started off with a down January two years in a row, I don't like how many companies are still struggling to move product.

The good news is that my economic analysis suggests that the business cycle still has about a year left to run, the market's ever-hopeful spring season is not far off, and we might see some half-decent quarters again later in the year. The key is how long "about a year" for the cycle ends up being. I'm not rhapsodic, but I'm not exiting quite yet.

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M. Kevin Flynn, CFA, is the president of Avalon Asset Management Company in Lexington, Mass. Website: avalonassetmgmt.com .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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