In Jeff Mortimer's September 2018 Investment Update, rather than look at this bull market's extraordinary age, he prefers to focus on the fundamentals, which appear to remain strong.
When my wife and I left the East Coast for the West Coast in the late '90s, we quickly began looking for a home. We soon discovered that the key question to ask sellers was not “How energy efficient is the home?" but “Has the home been retrofitted?" The climate in Northern California is much more temperate relative to the East Coast, but in the West you need to consider the potential for earthquakes. The home's foundation thus becomes one of its most important features, as a strong one can make your home resistant to even major tremors. My wife and I ended up buying a home that had recently been gutted and rebuilt to meet California's tough earthquake standards. It made us feel safe in our new environment, especially as we dealt with a threat with which we were unfamiliar.
The foundation of the market is made up of revenue, earnings and consumer spending.
Historically, at this mid-to-late point in an economic expansion cycle, revenue growth tends only to range between 4 to 6%. This past quarter, revenue growth came in at 10.3% compared to the same quarter last year. Seeing topline growth surge is a positive, transparent sign of success.
Earnings were also robust, with S&P 500 earnings for the second quarter, as measured by Thompson Reuters, up 25% year-over-year. This reflects the strength of revenues as well as the cut in the corporate tax rate.
Not to be left behind, profit margins are also at all-time highs. Profit margins, defined as earnings divided by revenues, rose to a record 10.9%. This comes in spite of all the talk about rising input costs and higher wages. Even if margins were to come down slightly from these record levels, history shows that equity market rallies can continue even as margins contract. Remember, it wasn't too long ago that we were writing about the five-quarter-long earnings recession. It seems as if companies have come out the other side in excellent condition.
Consumers, who represent two-thirds of the U.S. economy, are also performing admirably. Consumer spending, bolstered by last year's tax cuts and a strong labor market, increased at a healthy clip of 0.4% in July. After a strong July, retail sales moderated in August, but are up 6.6% year-over-year. And retail sales should continue to be supported by consumers' upbeat outlook as measured by the Conference Board's consumer confidence index, which jumped 5.5 points to 133.4 in August, its highest level in 18 years. Such a strong reading of consumers' assessment of current business and labor market conditions should bode well for consumer spending moving forward.
We believe that earnings and consumer spending will continue to be the major drivers of the equity market's upward trend going forward.
The current equity bull market, which began in March 2009, recently extended its nearly 3,500-day run to become the longest bull market ever on Wednesday, August 22, 2018. In fact, since the market low in 2009 through the end of August, this market has gone on to make about 200 new daily highs. Despite this, there has been much debate along the way over this market's ability to continue to climb, with many claiming its days were numbered just because of the bull's extraordinary length. We have not been among these skeptics, and are not about to join them now. I have always looked at new highs not with fear, but with positive anticipation. Exhibit 1 shows why. Historically, hitting a new 52-week high after having gone six months without one has been a positive sign for markets going forward.
While this chart shows the market may be predicting its own healthy future, we believe the economic backdrop also supports this view. The recently released 4.2% second quarter GDP figure continues to illustrate that the U.S. economy remains on very stable footing and seems to be gaining momentum. The rest of the world, however, is having trouble keeping up, with some signs of slowing in the Eurozone and some emerging market countries (including China). This should continue to have positive ramifications for global growth as a whole. Our view continues to be that the U.S. will grow at above the long-term trend growth rate of 2% in 2018, at trend in 2019, with the potential of below-trend growth not happening until 2020. This should prove a good backdrop for global equity markets in the near-to-intermediate term, especially if inflation remains contained.
With that said, there are potential risks that could disrupt this bull market. While trade negotiations are showing signs of progress, there is the potential for tensions to escalate between the U.S. and China and negatively impact our growth outlook and the markets. Or, we could see a quicker trade resolution resulting in stronger economic activity and potentially hotter inflationary pressures, which could cause the Federal Reserve to increase short-term rates at a faster pace than the market is expecting. While we don't foresee either of these scenarios transpiring, we continue to watch developments on the trade front and how it may impact the long global expansion. Also on our radar are the U.S. midterm elections and ongoing weakness in emerging markets, which could cause additional bouts of volatility.
Rather than look at this bull market's age, we prefer to focus on the fundamentals, which appear to remain strong. U.S. economic growth is leading the global expansion, and while corporate earnings may have peaked in the second quarter with a 25% year-over-year growth in earnings, we still expect companies will deliver solid earnings in the quarters to come. Although there are risks to monitor, this market has been extremely resilient and able to withstand the daily storms thrown its way.
So although this market may be in unfamiliar territory because of the length of the rally itself, relying on a strong foundation should enable equity markets, especially those in the U.S., to continue to press higher.
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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