Opinion among investors has been divided over whether the US equity market has further to run or whether a correction will put an end to one of the longest bull markets on record.
The current US bull market began in March 2009 in the aftermath of the global financial crisis and is the second longest on record. However, it would need to run for another few years to equal the longest run on record which ran from 1987 until 2000.
Indeed, commentators have questioned whether valuations can be sustained with the S&P 500 having already risen by 13.3 per cent, in US dollar terms, in 2017 (to 28 September).
Annualised total return of S&P 500 since 2008
Source: FE Analytics
The index has recorded successive annual total returns since 2008, as the above chart shows, enjoying its best year in 2013 with gains of 31.55 per cent.
Writing earlier this month, John Higgins, chief markets economist at Capital Economics, said the consultancy had recently upgraded its forecast for the index from 2,400 for the year-end to 2,500.
He said: “We have been surprised by the strength of the S&P 500 this year. Nonetheless, we don’t expect the index to make even more headway between now and the end of 2018. And we continue to anticipate a major correction in 2019.”
Higgins added: “We don’t think that the valuation of the S&P 500 is unsustainably high. As a result, we doubt that the index will come crashing down under its own weight.
“We do think, however, that the index is likely to fall sharply in 2019 – our revised end-year forecast is 2,150 – as the US economy starts to falter.
“In the past, most major corrections in the index have occurred in the run-up to, and during, recessions.”
The current US bull market began in 2009 following the global financial crisis, but it would need to run for another few years to equal the longest run on record which ran from 1987 until 2000.
Below, FE Trustnet asks fund managers and industry professionals whether the bull-run is sustainable.
Jeff Rottinghaus, portfolio manager of the $414.6m five FE Crown-rated T. Rowe Price US Equity fund, said it was not forecasting an imminent market correction.
“While we are not expecting a sharp correction in US equity markets, neither are we anticipating a dramatic acceleration in global economic activity,” he explained. “Current valuations are indisputably elevated, but there are also reasons to be constructive.
“The employment backdrop within the US has been consistently strong for the past several years, inflation is in check, and most measures of confidence remain high.
“Add in the recent strength seen from US corporate earnings and you could make an argument this upward trend could continue for a while. My base case is that, absent any dramatic geopolitical events, US equity markets continue to grind higher over the next several quarters.”
Rottinghaus said the list of winners and losers in the US equity market varied widely and reflected different investment styles.
“Some of the best performance has been delivered by well-known, rapidly growing e-commerce players – an industry many consider representative of the traditional ‘growth’ style,” he explained.
“What is perhaps surprising is that US airlines – historically viewed as more ‘value’ – has also been one of the best places to have been, as the industry structure improved materially following consolidation.
Performance of indices over 8yrs
Source: FE Analytics
“At the other end – investors in natural resources, specifically those within the oil & gas industry and within metals and miners, have generally seen weaker returns.
He added: “It has been a difficult environment and we expect it will remain challenging for the foreseeable future, given the production growth anticipated from ongoing gains in productivity and innovation.”
“The fact equity markets have continued to grind upwards is no great surprise,” said Colin McQueen, manager of the four crown-rated Sanlam FOUR Stable Global Equity fund.
“The distorting impact of QE and its global variants has kept rates low and liquidity high. In this environment, equities provide the least-ugly option, as long as nothing meaningfully rocks the boat.”
McQueen added: “In this environment, markets are hanging on every word from the central bankers.
“Threats to end the era of cheap money have yet to be followed up with much action – but with bubbles inflating in many areas, a desire to touch the brakes without causing those bubbles to go bang is clearly there.”
The chart below from the Organisation for Economic Co-operation & Development (OECD) shows long-term interest rates – represented by US Treasuries maturing in 10 years, implied by the prices they trade at rather than the rate they were issued at – remain low.
Long-term interest rates, Total per cent per annum
Source: OECD
“It does feel [like] caution will be the way forward and it could be some time before higher rates are sufficient to make cash and bonds a more desirable home for the flows currently going into equities,” said McQueen. “But with valuations now at their highest points, outside of the tech bubble, future returns are inevitably contracting as risks of pullbacks grow.”
The manager said it would be a “mistake” to think of equities uniformly however, adding that one surprise was the narrow nature of the current bull market.
“Maybe this is the nature of late-stage bull markets, as we saw with the 'Nifty 50' or dotcom frenzies,” he said.
“The ever-increasing multiples for a number of high-growth tech names also threatens the status quo.
“The variation in valuations is widening, as high growth companies attract investor and index buyer flows, while significant parts of the market seem becalmed and out of favour. Momentum can last an unpredictably long time, but it will end and usually when we are least expecting it.”
Eoin Murray, head of investment at Hermes Investment Management, said the continued rise of the US equity market has halted talk of asset bubbles and prompted some to dismiss the Federal Reserve’s plans to reduce its balance sheet.
“We have not seen my two favourite signals of having reached a market top just yet,” he said. “Firstly, the point when some market participants will try to convince you that we are faced with a new paradigm and that you just do not understand.
“Secondly there are still plenty of bears around – and we really should expect them to capitulate before we have truly entered the death throes of this run.
“Additionally, technical momentum is still providing a strong tailwind – the shift to passive and volatility-targeting strategies continues apace and these are adding to equity positions too. However, now is not the time to be complacent.”
Indeed, Richard Nackenson, portfolio manager of the Neuberger Berman US Multi Cap Opportunities fund, said it might not be the best time to make index allocations and should instead focus on active managers with a bottom-up focus.
“Recently, the end of ‘free money’ and zero interest rates has helped re-establish a rational market pricing mechanism and may create a background for better informed business decision making and risk taking,” he said. “In our view, this creates an excellent environment for bottom-up active managers. There are certainly US companies that are overvalued.
“That is why we argue that investors may want to avoid allocating to broad-based asset buckets and index funds.”