The Bull Market Isn't Over Yet
My favorite stock-market analyst tells why new highs are likely.
Stocks are overpriced, the economy is still growing too slowly, and corporate profits stink. But this bull market, now nearly 7½ year old, still has room to roam.
That’s the word from my longtime favorite market strategist, Jim Stack. Stack, who edits the InvesTech Research newsletter, has become increasingly bullish in the past few months—and I think he’s right.
Why listen to Stack? Because he has a terrific long-term record. Indeed, the last time he made a big mistake was in the late 1990s, when he turned bearish too early. More recently, Stack briefly turned bearish in early 2016, but only lowered his recommended stock allocation to 65%. Soon after, the market rallied and he became bullish again. But overall, Stack has been on target or close to it with most of his market calls.
Over the past 15 years through January of this year, InvesTech’s model portfolio returned an annualized 8.7%—an average of 2.3 percentage points more than Standard & Poor’s 500-stock index. That’s based on data from the Hulbert Financial Digest, which, unfortunately, ceased publishing after February. Stack is currently recommending that clients keep 81% of their assets in stocks and the remainder in cash.
Why no bonds? “Bonds are the most overvalued they’ve been in history,” he says. With the benchmark 10-year Treasury bond yielding just 1.5%, I agree with Stack.
Stack isn’t predicting a huge run-up in stocks. He figures that stocks will produce high-single-digit percentage gains before the bull market ends, probably sometime next year. But he has been a nervous bull for years now.
Stack cites four factors behind his bullish stance: the presidential election, the Federal Reserve, the market’s technical indicators and the economy. Let’s take them in order.
The election. This has nothing to do with who will win the presidency in November. Rather, it’s about how markets perform in presidential election years. In the 22 such years since 1926, the market has fallen in only four. What’s more, more than 80% of the gains came after midyear.
The Federal Reserve. Last December, the Fed snugged up short-term interest rates by one-quarter of a percentage point and indicated that it might tighten four times in 2016 as the economy continued to strengthen. Not surprisingly, the stock market headed south. The S&P 500 fell 14.2% from its May 21, 2015, high before hitting bottom on February 11. From then through August 22, the S&P 500 rose 16.2%%.
The Fed, worried about the global economy, has paced nervously on the sidelines since December. It is now expected to raise rates just one-quarter percentage point this year, and that probably won’t be enough to unsettle the market.
Market technicals. In making his market calls, Stack puts a lot of emphasis on dissecting the ups and downs of the stock market and its individual stocks—often referred to as technical analysis. His favorite indicator, called the negative leadership composite, measures, among other things, how many stocks are reaching new 52-week lows. “New lows are a telltale sign of a developing bear market,” he says.
Investors tend to sell their winners in most market conditions, academic studies have shown. Only when they’re fearful are they likely to dump stocks that are setting new lows. “When new lows are increasing, investors and institutions are selling,” Stack says.
That’s not happening now. In fact, Stack’s proprietary negative leadership composite is above 40—a level typically found only at “the start of a brand new bull market.” Because the current bull market began on March 10, 2009, making this one of the longest bull markets ever, Stack says that we’re in a new leg of the bull market.
Stack and other analysts also describe the current market advance as broad—a lot more stocks are going up than down—which is a bullish sign. Narrow advances, when investors are bidding up just a relative handful of stocks, tend to presage bear markets.
In 2015, Stack’s technical crystal ball became cloudier. He gradually cut his stock holdings to 65% by early this year. But in the past few months, as the market’s technical indicators turned more bullish, he raised his recommended allocation to stocks.
The economy. Today’s economy gets little respect. Yes, gross domestic product has been growing at only about 2% annually for years. But slow growth is better than no growth. What’s more, consumer confidence and the Conference Board’s index of leading indicators are both giving off high readings—signs that the economy will continue to grow, perhaps, at a healthier rate.
Are there worms in the apple? Oh yes. Stack wouldn’t be a market strategist if he didn’t worry all the time. His biggest concern, and he’s hardly alone in this, is that the market is expensive. The price-earnings ratio of the S&P 500 is currently 25, based on earnings over the past 12 months. The average P/E for the S&P since 1928 is 17. For the S&P to fall back to that level, assuming earnings are flat, it would have to plunge 32%.
Price-earnings ratios and other measures of value tend to give investors an indication of how big a market sell-off might be when it inevitably occurs, Stack says. But they tell you nothing about when a sell-off might start.
Where to invest? Given that we’re in the latter stages of a bull market, Stack favors industrials, health care and technology, as well as companies that make consumer necessities. He is bearish on financials and companies that make consumer products that aren’t necessary for day-to-day living.
Steve Goldberg is an investment adviser in the Washington, D.C., area.