Looking ahead to a great bull market
June 20, 2018
I believe there’s a great bull market still ahead of us.
I know. It’s optimistic, and, yes, you might expect that from a growth equity manager. I believe we are in the early innings of a great expansion in the market that has legs for the next to 10 to 12 years and will create more value than ever as new growth trends emerge. I don’t expect it to be a smooth ride. For example, the market just had a correction in February. But we believe that if past cycles and trends are a guide to a potential future path, then it’s possible that the market can triple by the end of the next decade.
Unfortunately, we see many investors who are poorly positioned for this event. Some may have become heavily invested in income strategies and have been avoiding equities for fear of market downturns. At the same time, we have seen a tendency to rely on high-fee alternatives that lack upside potential, or in passive strategies that can simply serve to mark time.1 We believe this positioning reflects a fearful mindset that has been ingrained over the last decade. When the majority is fearful, it’s important to be open minded to an upside scenario and realize that the real risk could be in not taking one.
Market swings over the years
Throughout the history of equity markets, we have seen major swings from confidence to fear and back again. Interestingly, these swings seem to be generational in scope. Confidence in the future is often technologically driven while times of fear tend to be fuelled by larger macro events. Based on this history, it could be argued that current signs of confidence are telling for today’s market. To illustrate, let me briefly review past swings.
In 1929, with the stock market crash, we entered the Great Depression. Unemployment peaked at 25% in 19332, 50% of banks failed, and we had war which is not uncommon in times of economic strife. The market didn’t hit new highs until 1950, the start of a great expansion. From 1950 to 1968, the market, as shown in the chart below and measured by the S&P 500 Index, rose more than 500%, largely driven by growth trends in key industries. The automotive and telecommunications industries hit critical mass during this period. The airline industry literally took off, and the development of the interstate highway system and container shipping industry ramped up the country’s logistical capabilities3. Massive value was created in the market as a result of macro fears being diminished by confidence and these strong trends.
Fear to confidence: The Great Depression ends and new trends emerge
Source: FactSet, as interpreted by Macquarie, price of S&P 500 Index for the period from Dec. 31, 1929, to Dec. 31, 1968. The war represented as a macro event was World War II.
The market peaked in 1968 and didn’t break out again until 1982. In that intervening period in the 1970s, macro issues again weighed on investing. Inflation marked the decade, sparked by a huge spike in the price of oil from $3 to $30 a barrel4 as a result of the Arab oil embargo. We again had war. Interest rates went above 16% for Treasury bonds, and mortgage rates hit nearly 20%!5 Not an easy time.
From 1982 to 2000, the market expanded dramatically, rising 1400% over that period as seen in the chart below. Again, in our view it was driven by a few strong trends: the globalization of American brands like Coke and Nike; the PC revolution from Microsoft and Intel; and the advent of big box stores such as Home Depot and Walmart. In each case, the trends were broad in scope, long lasting, and caused by a disruptive process followed by an improved way of doing things.
Fear to confidence: From inflation to the dawn of the Internet
Source: FactSet, as interpreted by Macquarie, price of S&P 500 Index for the period from Jan. 1, 1969, to Dec. 31, 2000. The war represented as a macro event was the Vietnam War.
It’s important to note that these great expansions didn’t come without their share of hiccups. For example, we saw the market crash in 1987, a recession in 1990-1991, a variety of currency crises in the 1990s, and the blow-up of Long-Term Capital Management6 in 1998. Still, through it all, great value was created, dominated by trends.
From 2000 to 2014 the market was flat again for a long period. The tech wreck, the consumer debt bubble collapsed and again, war, all hit the market and caused a period of fear that changed people’s mindsets and is still present in their portfolio positioning.
Fear to confidence: Out of the tech wreck and bubbles, new possibilities
Source: FactSet, as interpreted by Macquarie, price of S&P 500 Index for the period from Dec. 31, 2000, to Dec. 31, 2017. The war represented as a macro event were the Afghanistan conflict and Iraq War.
Finally breaking out
We finally emerged from our generational decade of lost economic growth when the market broke out in 2014. We believe this expansion will again be marked by major trends. As trend investors, we look for big markets undergoing structural change. We then try to identify the leader of the trend and insist that the company has strong fundamentals before investing.
Why will this expansion continue? The creative and destructive process that gives rise to powerful cycles is evident throughout many sectors of the economy. Technological capabilities and efficiencies are soaring, underpinning major innovations in sectors such as financials, consumer, healthcare, and technology. At the same time, the economy is healthy. Unemployment is low, and wage growth, while modest, has finally begun.7 The most recent readings of consumer and corporate CFO confidence are at all-times highs.8 Consumer credit scores are strong9 and banks are undergoing deregulation, all of which is helping to smooth the way to resume lending. These developments support that we are in the early innings of market expansion.
Huge markets, big transformations
Think about it. We are witnessing huge markets undergoing massive transformations. Mobile services, content, banking, food quality, new cancer cures, and the Internet of Everything, are all changing our world forever in so many ways. These are all immense markets. A vast amount of secular change lies before us, making it an exciting time to be an investor.
Passive, alternatives, and income strategies gathered a lot of assets in a post 2008 world. During times of fear it is much more difficult for active managers to outperform as the trends are less robust and lack of confidence drains momentum. We believe now is the time to be active with your investments.
So, consider an upside scenario and assess your portfolio’s alpha potential. Are you prepared if history rhymes again?
1Stock ownership has dropped among Americans since the global financial crisis, from 62% in 2008 to 52% in 2017 (source: Gallup).
2Swanson, Joseph; Williamson, Samuel. Explorations in Economic History, 1972.
3The auto industry prospered in the US after World War II, so that by 1966, the Big Three automakers (Chrysler, Ford, and General Motors) held 89.6% market share (source: Economic Policy Institute, 2015). The telecommunications industry was transformed in the 1950s and 1960s with the proliferation of television and the development of satellite technology for both television and telephones. Telecommunications along with avionics were instrumental in the advancement of navigation functionality for air travel. With other efforts such as airport development, improved flight operations, and technical innovations, the airline industry, including international air transport, grew at double digit rates from the post-1945 period until the first oil crisis in 1973 (source: International Air Transportation Association).
4The oil crisis began in October 1973 when members of the Organization of Arab Petroleum Exporting Countries (OAPEC) proclaimed an oil embargo, which caused a crisis or “shock” with sharp increases in oil prices. This was followed by the 1979 oil crisis, referred to as the second oil shock. Annual average prices of US crude oil were $3.60 a barrel in 1972 before the first crisis, and $37.42 a barrel in 1980, after the second crisis (source: Bureau of Labor Statistics).
5Top mortgage rate for this period was an 18.45% interest rate for a 30-year fixed mortgage in October 1981 (source: FreddieMac).
6Long-Term Capital Management (LTCM) was a hedge fund with more than $125 billion in assets that had returns of more than 40% in 1995 and 1996. Its risky trades, however, brought it to the brink of bankruptcy in 1998. Due to the size of LTCM and concerns that its collapse would trigger a financial crisis, the Federal Reserve took steps to bail it out.
7Unemployment for May 2018 was 3.9%. Rate of wage growth was 0.2% for May, or a year-over-year gain of 2.7%. (Source: Thomson Reuters.)
8Consumer confidence, as measured by the Consumer Sentiment Index, was 99.4 on May 1, 2018, one of the highest levels in 50 years since the top level of 109.6 on Feb. 1, 2000 (source: University of Michigan). US business optimism among CFOs was recorded at 73 in December 2017, the highest optimism ever recorded in the history of the survey (source: Duke University’s Fuqua School of Business and CFO Magazine Global Business Outlook survey, 2017).
9Average credit scores from VantageScore Solutions improved 11 points from 2007 to 2015, reflecting a rebound from the global financial crisis. Average FICO scores hit 700 in April 2017, the first time since the start of the scores in 1989 (sources: MyFICO.com, New York Federal Reserve Consumer Credit Panel, Equifax, VantageScore).
The views expressed represent the Manager’s assessment of the market environment as of June 2018, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.
The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the US stock market.
The University of Michigan Consumer Sentiment Index is a national survey of consumer confidence conducted by the University of Michigan in 48 contiguous states and the District of Columbia. The index uses telephone surveys to gather information on the expectations regarding the overall economy of adult consumers from the age of 18 and up. An index is unmanaged and one cannot invest directly in an index.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.