GLC Insights - Riding the backside of the U.S. bull market

An inverted yield curve, a pig that can fly, and the tail end of a bull market. Three big market themes happening right now, what to make of them and what to do next.

Part 3: Riding the backside of the U.S. bull market

It ain’t over ‘til it’s over!

If you haven’t read part 1 of this 3-part series, the inverted yield curve, or part 2, China's Year of the Pig, we suggest you start there.

To view the full outlook report with all accompanying sections, tables and charts, please see the attached PDF reports at the bottom of this article. All data is current as of April 15, 2019.

If you wish, you can also listen to a podcast about this article:

Amin: Hello, I’m Amin Barakat, Vice-President at GLC Asset Management Group.

Welcome to the third and final installment in our series of podcasts we are bringing you on three big market themes happening right now, what to make of them and what to do next. The three themes are the inverted yield curve, the outlook for the US and Chinese economies and in this podcast we discuss the anatomy of a bull market.

Before we get started, I want to mention that listeners can access all of GLC’s podcasts through our website or subscribe to the podcasts through Apple’s app, Google Play and Spotify by searching GLC Asset Management.  You will get new episodes automatically when they are released.

I would like to welcome our featured speaker for all three of our series of podcasts, with me is Brent Joyce GLC’s Chief Investment Strategist.

Brent: Hello Amin, great to be here again.

Amin: Brent, We’ve noted several times that we feel we are at the late stages of this market cycle. Investors are looking for signs everywhere – be it the inverted yield curve last month, the outlook for China, world trade developments or other considerations, to figure out how best to position their portfolios. What sage advice would you give to someone who’s trying to read the investment tea leaves today?

Brent: If reading the investment tea leaves means someone is trying to look for clues or signals to try their hand at market timing, I would caution against that strategy. Using any one market signal as reason to try and time the markets is not advised. Market-timing requires getting two decisions right – when to get out and when to get back in. Empirical evidence suggests that investor emotions (greed and fear) are far too powerful for market timing strategies to be fruitful.

This series of podcasts was born out of the inordinate amount of media attention we saw being paid to the inverted yield curve back in March. What we wished to outline for our investors are three things we think they should be considering today before making any rash, knee-jerk reactions to their investment portfolios. In part one, we outline a host of considerations around the yield curve inversion and in addition to concluding that the current brief episode of partial yield curve inversion is more a symptom of current central bank policy, and less a harbinger of recessionary outcomes. We highlight that an examination of the past 5 yield curve inversions going back to 1978, illustrates that on average it took 21 months between the first yield curve inversion and the onset of a recession. And It took on average 16 ½ months between the first yield curve inversion and the eventual peak in the S&P 500, and during that time the S&P 500 gained an average of 24%.

In part two we outlined a case whereby the U.S. and Chinese economies see better growth toward the back half of 2019 that will justify the current moves we are seeing in equity markets and lift bond yields in the latter half
of 2019. When we combine these themes, we see an environment where we
don’t believe it is necessary to dramatically alter the orientation of a well-built balanced portfolio that is suited to one’s investment goals, time horizon and risk tolerance. There are enough risk and uncertainties that investors with shorter term time horizons (less than 3 – 5 years) and/or those who have specific capital requirements in the near-term (or recurring), should look to have those near-term needs allocated in cash, or cash equivalents.

Amin: So on average the U.S. stock market gained 24% after the yield curve inverts. I imagine that many investors would be surprised to hear that strong gains – sometimes even an acceleration in performance, can be seen at the latest stages of a bull market. 

Brent: Yes, when you parse through the data, like we did, you have to recognize that equity markets have historically generated outsized gains in the first year of a bull market, and the last. Going back to 1949, the average gain in the first year is 36%, then in the intervening years, however long they have lasted, the average annualized gain was 13% and in the final year of a bull market the gain has averaged 20%! We are clearly not in the first year of a bull market, of course we are into historic territory for this bull market on the S&P 500, now well into its 10th year. So we do know what the first years gain was, that was from March 9, 2009 to March 9, 2010 and that was a whopping 69% - now for context, that was after a miserable 56% decline preceding that move. And we also know how we have been faring in the intervening years – that is actually running below the 13% average, we have compounded the S&P 500 at 11% since March of 2010 to March of 2019. The real problem lies in the fact that we don’t know what the last year’s return will be, or when it will come?

Amin: Right, but we have illustrated how tough trying to time markets can be and that risks of being out of market are just as significant on the financial well-being of clients as the risks of being in the market. It sounds like you’re making a strong case for letting your long-term plans, rather than the endless daily barrage of economic data and news flow, drive the decisions for one’s investment mix?

Brent: That’s right Amin. For us, we don’t use arbitrary time stamps, or so-called market signals. We focus on the data and evidence at hand. Weighing all of the evidence, and understanding it correctly, and reviewing it objectively, not just one or two so-called signals. When we do this at present it leads us to conclude that a neutral position is most appropriate. Maintaining a neutral position across both equities and fixed income (in proportions that align with your risk-tolerance and time horizons) appropriately takes into account both the opportunities and risks that the current market backdrop presents.

Amin: Thanks Brent. All three instalments in this series of podcasts covering current major market themes, first being the inverted yield curve, second the outlook for China and the U.S., and this last one on the anatomy of a bull market have help provide a broader perspective on overriding issues that investors are trying to come to grips with in managing their investment plans. 

We look forward to hearing more insights on our next podcast.

For those who are tempted to take the inverted yield curve as a signal to lighten up or exit their equity exposure, we would be remiss if we didn’t outline the cold, hard data around the opportunity cost associated with abandoning equities at the first sign of yield curve inversion. Equities have historically booked above-average returns for many months after the first instance of yield curve inversion (see Exhibit 3.1).

3.1 │S&P 500 Performance Post Yield Curve Inversions

Performance post yield curve inversions tends to be strong for months on end.

Table showing figures around past yield curve inversions and how they relate to S&P peaks and recession starts.

A clinical evaluation of the data in Exhibit 3.1 should really elicit a celebration of yield curve inversions on the part of equity investors.

While we’ve espoused for more than a year that we feel risks are rising due to the prolonged nature of the current market cycle expansion (i.e., the old age of this bull market), it’s also true that, historically, the tail-end of bull markets have been marked by outsized equity market gains (see Exhibit 3.2).

3.2 │Anatomy of a bull market

The beginning and end of bull markets have historically brought outsized equity market gains.

Diagram of post-World War 2 S&P 500 Bull Market Return Distributions. Demonstrates current bull market returns are higher in first year return and slightly lower in middle period.

These historical observations, coupled with the fundamental rationale, are the reason we see the recent yield curve signal as a red herring (as detailed in part 1 - the inverted yield curve). Furthermore, the evidence laid out in part 2 - China’s Year of the Pig provides rationale for the current global spate of soft economic data and outlines reasons for optimism for both China and the U.S. outlooks.

Bottom line:

Added together, we conclude the brief yield curve inversion witnessed in late March is not reason enough to abandon equity markets.

Putting views into action:

It’s no time to abandon your risk-appropriate equity position. In other words, the less sensitive you are to market volatility and the longer your time horizon before you need to draw income from your investments, typically, the more a higher equity allocation in a portfolio is appropriate. Investors with shorter-term time horizons (less than three to five years) and/or those who have specific capital requirements in the near term (or recurring) should look to have those nearterm needs allocated in cash, or cash equivalents. This will allow you to appropriately take into account both the opportunities and risks the current market backdrop presents.

Copyright 2019 GLC. You may not reproduce, distribute, or otherwise use any of this article without the prior written consent of GLC Asset Management Group Ltd. (GLC).

This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.