Who Would Win the Fight Between a Bull Market and a Bear Market Today?

 
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Most economists know forecasting the timing of a recession is a fool’s errand. I knew this in 2017 when I told clients I expected the stock market to climb higher until our next recession which may occur in the first quarter of 2020. Would I end up feeling foolish if my assertions did not hold true? Of course not. A lot can change in three years and I told clients I would be shocked if these predictions held true. Yogi Berra would remind us it is difficult to make predictions, especially when it involves the future. That said, it’s interesting to see several economic indicators insinuating we are on the brink of an economic slowdown as we approach 2020.

Investors began using the phrases “bull market” and “bear market” in the 17th century to describe trends in the stock market. Bulls attack with their heads up which explains why a bull market reflects an upward trending market. Bears attack with their heads down so a bear market is downward trending. At the time of this writing, the S&P 500 is within 2% of its all-time high set in July of this year. Is the ominous bear market around the corner or will the bull market stave off a recession and propel the stock market to new highs?

On the left, I’ll point out reasons to the market will reach higher. On the right, you will find the data insinuating the best days are behind us. The fundamental rationale supporting the bull market and a bear market will be battling each other over the next few months. This will be a fight worth watching.

The Bull Market

…In the red corner, weighing in at 2,400 lbs is the reigning heavyweight title holder and the undisputed champion of this economic expansion - the Bull Market!

The bull market is getting but it remains the favorite to win this fight as it still has weapons like consumer confidence, a robust labor market, healthy valuations, and easy monetary policy.

 

The Bear Market

…In the blue corner, weighing in at only 600 lbs is the challenger and making a comeback after more than ten years of hibernation - the Bear Market!

Don’t bet against this rested beast that will bring a flurry of global manufacturing weakness, an inverted yield curve, fading corporate profits, and ongoing trade uncertainty into the ring. The bear is back and ready to put on a good fight.

 
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Consumer Confidence

The consumer is doing great as household balance sheets are as strong as they have been in years. Their constructive view is expressed in surveys like the CB Consumer Confidence Index which it as levels as high as the tech bubble in the late 1990s.

Source: Conference Board, Investing.com.

Source: Conference Board, Investing.com.

 

A Strong Job Market

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The labor market continues to grow providing solid support for a continued expansion. Labor Department data Friday showed the U.S. extended a record 107-month streak of job creation, while a report Thursday showed the service sector grew for the 115th consecutive month.

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Source: Conference Board, WSJ.

Source: Conference Board, WSJ.

Furthermore, the job market is stable and workers feel confident in their prospects to find new work. This increases their propensity to spend which is a solid backdrop for a continued expansion. Right now, there are more job openings than unemployed persons in the United States. The Conference Board also measures the spread between respondents who say jobs are plentiful or jobs hard to get. This spread is at the highest level in the past two decades.

Relative Valuations

Source: Goldman Sachs, MSCI.

Source: Goldman Sachs, MSCI.

For the stock market, various measures of valuations appear to be average or fair for the U.S. stock market when compared to historical values. When factoring in the yield environment, valuations still appear to be attractive. Currently, the dividend yield for the average company in the S&P 500 is higher than the yield on 10-year U.S. government debt. In the chart below, the vertical grey lines indicate previous points in time where this has occurred. As you can see, strong equity returns have ensued.

Empirical Evidence

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Earnings growth for U.S. companies may have peaked. This is causing angst for investors. Interestingly enough, strong returns have followed prior earnings peaks, with positive returns 91% of the time over the subsequent two years.

Accomodative Monetary Policy

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In five prior rate-cutting cycles since 1984 that have happened outside of recessions, the S&P 500 on average rose 11% over the subsequent six months and 16% over the next year from the first cut (FactSet).

Growth in the Leading Economic Index

* Vertical grey bars indicate recessions

*Vertical grey bars indicate recessions

Finally, when the year over year growth for the Leading Economic Index turns negative, a recession has followed in every recession over the past 50 years. The Leading Economic Index is still showing positive year over year growth, which insinuates a recession is not going to occur in the immediate future.

 

Global manufacturing slowdown

Manufacturing only makes up a small percentage of the economic activity of developed countries. However, it is highly correlated to the health of a nation. The Institute of Supply Management gauges the health of the manufacturing. Readings above 50 are representative of a growing economy and readings below 50 exemplify a contracting environment. The latest reading in August was 49.1 pointing to waning growth. This is the first time the index has contracted in three years. Furthermore, manufacturing activity is not just a U.S. phenomenon.

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Various components of the ISM Manufacturing Index point to a notable decrease in business confidence.

Various components of the ISM Manufacturing Index point to a notable decrease in business confidence.

Rising Deficits

The trade deficit just hit a 10-year high. Massive deficits will weigh on the future growth of the nation for years to come as we must then allocate an increasing amount of our budget to interest payments.

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Ongoing trade uncertainty

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It’s difficult for business owners and corporations to plan future expenditures when the future of the business climate is uncertain. When this occurs, businesses stop spending and growth inevitably stalls.

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Perhaps this is the reason corporations have elected to use excess capital to buy back stock and pay dividends instead of investing in the future growth of the company through capital expenditures.

U.S. Treasury Curve Inversion

Saving the most lethal weapon as the last reason the bear may triumph. The treasury curve has just inverted. An ominous sign like a grizzly paw to the face. The yield curve is considered inverted with shorter dated bonds are yielding more than longer dated bonds. Most commonly, when the 10-year U.S. Treasury bond yields less than the 2-year U.S. Treasury bond. This happens when investors, foresee impending doom so they are willing to take the lower guaranteed interest rate instead of investing now at a higher rate, then run the risk of reinvesting at a lower rate. When the economy is strong, the yield curve slopes upward since investors assume rates will be higher in the future. Understanding the rationale, it makes sense why an inverted yield curve as preceded every post WWII recession. Below, the graph shows the 10-year U.S. Treasury yield minus the federal funds rates (i.e. cash rates).

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As the yield curve inverts, investors take note. Recently, searches for the word “recession” have spiked. Suggesting the public is growing concerned about the possibility of a recession.

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Don’t Turn Away from the TV

This will be a fight to remember. At Noble Wealth Partners, we have been watching these beasts spar for decades. The bull market is getting old and will not be able to hold the title much longer but the bear market just woke up and needs more training before it has what it takes to take the title. To us, a recession does not appear imminent but recession risks are rising. Investors should consider diversifying and possibly decreasing equity risk in their portfolios (depending on their starting allocation). Even if investors believe the bull will hold the title for undisputed champion of this expansion, we must be cognizant the bear market has the weapons to pull off the upset.