Secular Bull Update: Where next?


With our 2017 target of 2,350 on the S&P 500 already in the rear-view mirror and the 8-year anniversary of the bull market just passing last week, many clients are asking us, “Where next?” While short-term market moves are normally difficult to predict, longer-term ones are less so. (Said more technically, the volatility of stocks over a 3-month horizon is several times higher than the volatility over a 3-year horizon.)

So while many seers, ourselves included, are warning that a shallow correction in the next few weeks may literally be “where next,” I would not advise selling here to try to play for such a 3-to-5% down move. Our view remains that we are in a “buy-the-dips” environment until further notice—far from a “sell the rallies” mode. On a 12-month forward view, we expect our long-standing 2,500 forecast for the S&P 500 finally to be achieved. Beyond that, we see 3,000 as next in play, possibly for 2019. So, hold on to your equity-overweight bias and if we do get a pullback for technical or other reasons, add to it.

The secular bull phase one: The Aftershocks
To reiterate points made in previous musings, dating back six years (and really before then though we didn’t officially put a name to it until 2011), we believe we are in the midst of one of the great secular-bull markets that come along every generation—5-to-10 baggers off bear-market lows. In our view, this bull has just recently entered its third phase. The first, “The Aftershocks,” occurred from 2009 through April of 2013, when the S&P 500 completed a 140% run off its March 2009 low simply on the back of the news flow not getting any worse (a series of financial crises, "Greece 1, Greece 2, etc.," rattled the markets, only to prove to be weaker echoes of the Lehman crisis of 2008). The bears fussed and fumed, but Fed policymakers simply would not allow the economy to utterly collapse.

By the spring of 2013, the market was fast approaching the 14-year double top on the S&P 500 (1,585), which until then had proven to be a firm ceiling on any attempts to escape the long bear market that began in early 2000 as the tech bubble burst and the U.S. economy fell into recession. At this point, the bears were sure the market would finally roll over and retest (at least) the March 2009 low. But when the European Central Bank joined in, promising to “do whatever it takes” to save the European economy, the 14-year-long bear finally had to capitulate. That summer we called for a market melt-up, and sure enough we got one.

The secular bull phase two: Goldilocks Cubed
The resulting 2-year market melt-up to 2,100 through May 2015—a period we dubbed “Goldilocks Cubed’’—represented the second phase of the secular bull, driven by global central bank reflation and a “not too hot, not too cold’’ growth rate in the U.S. But when China looked like it might fall off a cliff and the U.S. energy patch hit a dry hole, even as Brexit and U.S. election votes loomed, the uncertainty index spiked, sparking a healthy 15% bull-market correction that twice retested the soundness of the 2013 breakout.

In both cases, the summer of 2015 and February of 2016, the bottom held firm at just under 1,900. This corrective phase, which we labeled “A Five Ones World,” ended in the summer of last year, when we definitively pushed through the 2,100 level on the back of having survived Brexit, China’s deceleration and an energy patch/industrial sector recession.

The secular bull phase three: The Wall of Hope
In November, the Republican sweep of both houses of Congress and the U.S. presidency promised a new era of growth-oriented leadership and reform in Washington, and this set the stage for the third phase of the secular bull, what we call “The Wall of Hope.” We think this phase, characterized by rising nominal GDP growth rates globally, another big leg up in earnings and very modest multiple expansion in stocks, is likely to take the S&P 500 to 3,000—and potentially beyond.

There are sure to be hiccups along the way—there always are. The closest one we see on the horizon is the potential election of Marine Le Pen—a nationalist who makes President Trump look like a Boy Scout—as France’s next president. Polls suggest it’s unlikely (will we ever really trust polls again?), but if it were to occur (the first round is in April, with a run-off among the top two in May), it would cast further doubt on the entire euro edifice.

So where next? That depends on your perspective. Assuming you are investing for the long haul, “next” is higher. Of course, there will be volatility along the way, but our bet is the foundations of the president’s reform agenda (taxes, health care, trade, infrastructure and deregulation) will be largely in place by this time next year. Concurrent with this positive policy shift, animal spirits are rising and nominal GDP’s growth trajectory is shifting higher. Earnings should follow. We have already lifted our 2018 earnings projection for the S&P 500 to $140, and given how far the Fed is from inducing another recession through too-high interest rates, $150 can’t be too far behind.

A runway to 3,000
In this kind of environment, with downside risks subdued and interest rates barely back to normal levels, history suggests that a P/E of 20 on the S&P 500 would not be unheard of, and would be still far from the frothy levels that typically call a top. That simple math takes us to what could be next: 3,000. Look for markets to trade toward that level through this third “Wall of Hope” phase. This should take us to somewhere into 2019 or so, we suspect.

At this level, the new millennium’s first big secular bull would have produced a 4.5 bagger off the dark and scary lows of eight years ago—less than the 26 bagger we got off the Great Depression lows (when literally the world as we knew it just about ended), and even less than the 12 bagger achieved off the lows of the Stagflation Bear of the 1970s.

“Where next?” from there will depend on how well Trump’s structural reforms are working, the state of the world economy and world trade, and whether inflation accelerates from a healthy level of 2-to-3% to something scarier that could bring with it more aggressive central bank action. For now, we appear to have a solid runway higher to 3,000. We can re-evaluate “Where next?” then.