How Far Will The Bull Market Go?
The bull has been running for a while now
- Asset classes around the world have been on a steady march upward.
- Asset-price booms have been a source of good cheer until lately when almost every asset is “priced to perfection”.
- Investors have been speculating how the existing bull market will end.
- Perhaps the best course of action would be to prioritise prudence over profits.
No one would mistake the immense run-up in global stock markets, credit and real estate prices over the last 9 years since the 2007 – 2009 financial crisis as one of the most spectacular bull markets in history. So much so that when the S&P500 index rose by 30% in 2013, many had troubles adjusting their expectations. Many investors and analysts alike has juxtaposed the current bull market to that of the dot-com bubble, the roaring twenties credit bubble or, depending on the asset class, the “Tulipmania” back in the 17th century.
One metric devised by American Nobel Laureate, Robert Shiller, is the Cyclically Adjusted Price to Earnings ratio or CAPE ratio. It is a valuation measure usually applied to the S&P500 index and it is defined as the amount of dollars used to purchase one dollar of earnings over the average of ten years’ earnings, adjusted for inflation. Right now, the CAPE ratio is standing at an almost all-time high as it flirts with passing 30 with the sharp increase in the equity index. Looking at the credit markets, investors have never been so risk-loving as they continue to pursue high-yield (read junk) bonds. Real estate prices all over the world have climbed steadily. Add to this the craze for exotica, such as cryptocurrencies and one can easily come to the conclusion that the bull market is rampant in almost every asset class in almost every part of the world.
Many would agree that asset-price booms are a source of cheer but rarely have so many asset classes exhibited such a sense of invulnerability. As a result, the bull market has led to anxiety rising amongst even the most optimistic of us.
- What’s Wrong with a Little Bull Market?
One thing that we know is that the existing bull market has been fuelled by an extremely loose monetary policy. Central banks around the world have kept short-term interest rates close to zero since the financial crisis and have helped depressed long-term rates by purchasing trillions of dollars of bonds through quantitative easing. Only recently has the Federal Reserve decided to unwind its $11 trillion balance sheet. It has started to raise interest rates (twice in 2017 as of this writing) and will soon start to sell its bond holdings. It is also very likely that other central banks will also follow suit by adjusting their interest rates and unwinding their swollen balance sheets. If the bull market has been fuelled largely by the central banks’ monetary and fiscal policies, investors might see a huge correction coming their way.
Secondly, a widespread of greed can be observed in the credit markets. Investors are not keen on buying treasury bonds because it does not give them a juicy 7% yield as compared to the bonds issued by Egypt, Iran, Argentina and Tajikistan. This can also be observed in the equity markets as investors have expressed their willingness to own stocks which does not even turn a cent of profit and bidding their prices to exorbitant levels.
- What Now?
“Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria.”
I believe that the quote above by Sir John Templeton is extremely wise and applicable in today’s context. The struggle here is in determining which stage of the bull market we are in right now. However, regardless of the stage, investors ought to implement countermeasures in place to ensure that come what may, their portfolios and wealth would still be protected.
We have heard horror stories of how people lose their entire savings as the stock market pulled the rug from under them. In order to prevent those situations from arising, one can prioritise the important of prudence over profits.
This can be done by first investing in companies and businesses that we understand or that is within our circle of competence. When the prices of these stocks decline, we will be able to identify the reasons for the decline and be less prone to making bad calls by selling too soon. Secondly, we can ensure that additions made into our portfolios are made with an extra layer of caution. This is where the concept of margin of safety comes in. It is a principle used by Warren Buffett and value investors in which an asset is purchased when the market price is below its intrinsic value.
By prioritizing prudence above profits, investors can effectively manage their downside risk and protect their wealth.
If you want to learn more about how to find cheap and good stocks to generate passive income for you, click on the picture below to join our Free Value Investing Masterclass.
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.