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How to spot the signs that a bull market is ending







Can the good times continue to roll? Nobody knows for sure, but we explain why you should be on your guard

Whether you have been invested in the stock market for the past ten years, or ten months, chances are that your shares have performed well. Stock markets around the globe have been in a bull market, a period of shares rising without significant interruption.

US markets have had an impressive eight years of growth with the S&P 500 index of blue-chip companies, the technology-focused Nasdaq and the Dow Jones industrial average all hitting successive highs. “Being a US equity investor over the past several years has felt glorious,” says Matt Kadnar, member of the asset allocation team at GMO, a fund manager.

It’s a similar story around the world. The UK’s FTSE 100, Germany’s Dax and the MSCI World index, which tracks a basket of global stocks, have had few interruptions and also risen to record peaks.

Now a question mark hangs over when the bull market will end. “It is remarkably easy to assume that it should continue indefinitely, but it is an extremely dangerous assumption when it comes to asset markets,” says Mr Kadnar.

“The average US stock has never been more expensive than it is now, even at the height of the insanity that was the [dot.com] bubble of the late 1990s. We have never seen such broad-based overvaluation of US equities.”

Technology stocks in the US bear the brunt of the criticism for being expensive, particularly the so-called Fang stocks — Facebook, Amazon, Netflix and Google, which is owned by Alphabet. But it’s not only the US that professional investors are criticising. “The present bull market is often described as ‘the most hated bull market in history’, with many calling it artificial or a bubble from the start,” says David Jane, a fund manager at Miton Group, the investment company.

WARNING SIGNALS

  • ‘Valuations become very distorted and investors make odd decisions’
  • ‘Keep an eye on the US. If its economy starts to turn, be concerned’
  • ‘Watch consumer sentiment, it can show how retailers will fare’

Such negativity has come about because many economists believe that the billions created through central banks’ quantitative easing programmes has flowed into stock markets. Very low interest rates (and negative rates in some countries) have helped to push down the returns on bond investments, so investors have put their money into stock markets instead, not always for the best reasons. Investors have shrugged off worries about company valuations (such as the price-earnings ratio, a key indicator of value in shares) and stocks have continued to rise.

“Equity markets are richly priced on the basis of pretty much every valuation metric there is,” says Nandini Ramakrishnan, a global market strategist at JP Morgan Asset Management. “The futility of getting anyone to care about prices, after years of central bank stimulus have helped share prices more than triple, seems evident.”

How can you spot the end of a bull market?
“You can’t. Usually market corrections or falls come out of the blue,” says Adrian Lowcock, the investment director of Architas, a multi-manager.

You can have an inkling, though. During the later stages of a bull run, valuations become very distorted and investors make odd decisions. Mr Jane believes signs of these phenomena are emerging. “A number of recent new equity issues have shown that the market has been a little too willing to finance businesses on hope rather than substance,” he says. The recent flotation of Snap, the owner of the Snapchat messaging app, is an example. Despite the company admitting it may never make a profit, it was valued at $30 billion. Snap shares are now trading at about $15, almost half the $29 achieved in March. However, extremely high valuations can be tolerated for years before a bull market ends. This phenomenon acts as a reminder to be judicious when making new investments.


The Fang stocks, including Facebook, Amazon and Google, have been criticised for their high prices

How does this bull market compare to those of the past?
It may be hated, but in some ways it is unremarkable. Mr Lowcock says that the length of a bull market in years is much less important than its magnitude, or how high markets rise.

Today’s bull market may be long in the tooth, but returns on the S&P 500 are still lower than they were in three previous bull markets, two of which also lasted significantly longer.

“It could still have much farther to run if it comes close to replicating either the periods of 1949-61, or 1987-2000,” says Mr Ramakrishnan.

What if the economy falters?
Economic downturns can end a bull run because the environment becomes difficult for companies to grow their earnings. Since the crash of 1929 that presaged the Great Depression, the S&P 500 has gone into a bear market ten times — a bear market is a fall of at least 20 per cent. Of these, eight occurred at the same time as a US recession, according to JP Morgan, the financial services company.

The key indicator is corporate earnings growth, both on aggregate for the market and for individual companies you are investing in. “If you get the earnings growth, the market can rise. Earnings growth is what has driven the US and Europe lately, and to a lesser extent the UK,” says Mr Lowcock.

Other key economic indicators to watch include consumer sentiment, which can show how retailers will fare; and business confidence, which gives perspective on the economy’s health. Most importantly, keep an eye on the US. “Its economy drives the rest of the world. If it starts to turn, I would be concerned,” Mr Lowcock says.

Economies and stock markets move in cycles and it’s normal for both to cool after a period of expansion. Typically, policymakers raise interest rates to ease inflation, which has the knock-on effect of calming the stock market. Although interest rates are on an upwards march in the US, there is little sign that they will be rising in the UK and Europe. “It doesn’t appear that the interest-rate cycle is about to end the bull market just yet,” says Mr Jane. “Policymakers appear to be extremely wary of the destabilising effect this would have.”

Should I invest in shares now?
When you buy shares in companies where valuations are already stretched, temper your expectations. “Whether or not a company eventually justifies its very high valuation is not the point. Your future returns will not be as high as if you had bought before it achieved that valuation,” says Mr Lowcock.

Do bear in mind that the best returns often come in the last few months of a bull market. Selling out too soon could mean you sell at a much lower price than if you had held on. “Now, with valuations so high, taking some profits and having a more defensive attitude is pragmatic. I do think that is sensible,” he says.