Bull markets do not die of old age. Instead, they are often killed when the Fed is forced to raise rates to combat high inflation, leading to an economic stumble.
When my dad taught me to drive, he offered the following advice about driving in the dark: "Don't outdrive your headlights."
It is advice I've been thinking about a lot lately, particularly at client events where I'm often asked, "When will this bull market end?" With the current bull market — the longest in history — and the U.S. expansion about to turn 10 years old in June, many investors are questioning whether it has the strength to keep going.
To answer this question, the Investment Strategy Committee (ISC), which I chair, forms both long- and short-term views of various asset classes across 7- to 10-year, 3- to 5-year and 12- to 18-month time horizons. These perspectives help us think about both short- and long-term risks that might influence when and how this bull market could end. Looking a little ways down the road can help us determine what we should be thinking now.
Our 7- to 10-year view is primarily tied to our work on our capital market assumptions (CMAs), which start with assumptions about growth and inflation and are adjusted to factor in our views of global markets. In our most recent outlook, we stated that we believe in modest economic growth going forward with low to moderate inflation and relatively steady interest rates. Our 10-year CMAs forecast more modest equity gains of 6 to 8% going forward, while also expecting a total return on fixed income investments roughly equal to today's current yields.
The 3- to 5-year time horizon allows the ISC to consider more intermediate-term variables. Valuation certainly plays a role here, but so do industry trends, global fiscal and monetary policy, consumer and business confidence, employment data and long-term measures of inflation. When we look at the markets through these lenses, we continue to generally like what we see. Global monetary conditions remain accommodative, confidence remains at very high levels, employment remains strong (especially in the U.S.) and valuations for most asset classes are reasonable.
With our long-term view as a foundation, we now incorporate a short-term view of asset class relationships over a 12- to 18-month time horizon. Our ability to develop forward-looking views for this shorter window of time ensures that we do not outdrive our headlights. Instead, we analyze key variables that help us determine whether our short-term view differs from our longer-term views and whether we need to make any shifts to our asset allocation. This short-term view, combined with the long-term context, allows us to better navigate the terrain that is right in front of us while never losing sight of our ultimate destination.
Some of the key variables we analyze are valuation, short-term measures of inflation, market sentiment, purchasing managers indexes, leading economic indicators, and changes to central bank and fiscal policies. Currently, the strength of these combined variables gives us confidence that consumers will continue to spend and businesses will continue to invest, at least in the short term. Inflationary pressures remain muted, causing the Fed and other central banks to take a more patient approach to monetary policy. We do not see a recession in 2019 or even 2020. This economic backdrop should bode well for global stock markets as we believe equities should continue to move modestly higher over the coming quarters, albeit with some fits and starts as variables such as inflation, U.S.-China trade, or a questioning of the Fed's pivot may periodically come into focus.
Inflation is a key variable that impacts financial markets over both short- and long-term time horizons. Inflation has been especially tame for the last decade. A few long-term trends may shed some light as to why. First, the global demographic trend toward a higher median age puts downward pressure on inflation as older adults tend to save more than spend. This leads to lower yields as they compete to purchase low-risk bonds. Second, technology, especially as it relates to price discovery (the ability of a consumer to compare prices between sellers), also puts downward pressure on prices. It makes it very difficult for any single seller to raise prices, helping keep a lid on inflation. Finally, the short term, productivity has also started showing signs of accelerating. This improvement is disinflationary as it allows businesses to increase their profit margin without raising prices because workers are more effective at pushing out more products or services. All three of these trends keep inflation well-contained, which is a very good outcome for investors. Low inflation allows the Fed to continue to be patient about raising rates.
The current softness in inflationary pressure and slowing economic growth led the Fed to shift to a more dovish monetary stance in early 2019. Jobs, housing and sentiment data have looked more promising recently, which supports our expectation for economic activity to pick up in the second half of the year. Even with better economic activity, we believe the Fed will remain on hold largely because its preferred measure of inflation, the personal consumption expenditures (PCE) index, is still below its 2% target.
While markets have rebounded somewhat following the weakness in global growth during the final quarter of 2018, the current escalation in trade tensions could end up weighing on growth and corporate profits if both sides are unable to reach a resolution soon. Given that China exports roughly $540 billion to the U.S. compared to the $120 billion of goods it imports from the U.S., they clearly would feel the brunt of the economic pain. Most economists believe that trade tariffs will result in about a 0.5% decline in U.S. GDP and 1.0% decline in China's GDP over a year. But if President Donald Trump moves forward with an additional round of tariffs on $325 billion of Chinese imports — essentially, consumer goods — the cost could weigh on corporate profits if not passed along to consumers.
Our base case remains that the U.S. and China will reach some time type of modest deal, but it is difficult to know what that may look like at this time. We could see all tariffs come off, agreement on some structural reform or a combination of the two. But the longer the uncertainty continues, the greater the potential negative impact to growth. With that said, we believe the U.S. economy is strong enough to withstand a possible drag from the trade tensions, but we will continue to monitor developments to see if it changes our forecast for a continued but slow global expansion.
Bull markets do not die of old age. Instead, they are often killed when the Fed is forced to raise rates to combat high inflation, leading to an economic stumble. For now, we do not think the Fed will need to raise rates any time soon. But just as my dad taught me about not outdriving my headlights, the ISC will continue to look into the future, analyzing variables across multiple time horizons in order to determine when this economic and market cycle may end. At this point in time, at least as far as we can see, the coast looks clear.
This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. The Bank of New York Mellon, Hong Kong branch is an authorized institution within the meaning of the Banking Ordinance (Cap.155 of the Laws of Hong Kong) and a registered institution (CE No. AIG365) under the Securities and Futures Ordinance (Cap.571 of the Laws of Hong Kong) carrying on Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activities. The services and products it provides are available only to “professional investors" as defined in the Securities and Futures ordinance of Hong Kong. The Bank of New York Mellon, DIFC Branch (the “Authorised Firm") is communicating these materials on behalf of The Bank of New York Mellon. The Bank of New York Mellon is a wholly owned subsidiary of The Bank of New York Mellon Corporation. This material is intended for Professional Clients only and no other person should act upon it. The Authorised Firm is regulated by the Dubai Financial Services Authority and is located at Dubai International Financial Centre, The Exchange Building 5 North, Level 6, Room 601, P.O. Box 506723, Dubai, UAE. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon London Branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. The Bank of New York Mellon is incorporated with limited liability in the State of New York, USA. Head Office: 240 Greenwich Street, New York, NY, 10286, USA. In the U.K. a number of the services associated with BNY Mellon Wealth Management's Family Office Services– International are provided through The Bank of New York Mellon, London Branch, One Canada Square, London, E14 5AL. The London Branch is registered in England and Wales with FC No. 005522 and BR000818. Investment management services are offered through BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, One Canada Square, London E1C 5AL, which is registered in England No. 1118580 and is authorised and regulated by the Financial Conduct Authority. Offshore trust and administration services are through BNY Mellon Trust Company (Cayman) Ltd. This document is issued in the U.K. by The Bank of New York Mellon. In the United States the information provided within this document is for use by professional investors. This material is a financial promotion in the UK and EMEA. This material, and the statements contained herein, are not an offer or solicitation to buy or sell any products (including financial products) or services or to participate in any particular strategy mentioned and should not be construed as such. BNY Mellon Fund Services (Ireland) Limited is regulated by the Central Bank of Ireland BNY Mellon Investment Servicing (International) Limited is regulated by the Central Bank of Ireland. BNY Mellon Wealth Management, Advisory Services, Inc. is registered as a portfolio manager and exempt market dealer in each province of Canada, and is registered as an investment fund manager in Ontario, Quebec, and New Foundland & Labrador. Its principal regulator is the Ontario Securities Commission and is subject to Canadian and provincial laws. BNY Mellon, National Association is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept responsibility for the accuracy or correctness of any of the statements made or advice expressed herein. BNY Mellon is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept any responsibility for the accuracy or correctness of any of the statements made or advice expressed herein.
Trademarks and logos belong to their respective owners. BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation.
©2019 The Bank of New York Mellon Corporation. All rights reserved.
Director of Investment Strategy, BNY Mellon Wealth Management
Jeff Mortimer is the director of investment strategy for BNY Mellon Wealth Management. In this role, he leads a team that sets capital market expectations and is responsible for making asset allocation recommendations. Jeff has more than 25 years of experience in the financial services industry.View Profile