This time last year, stocks were plunging as the Federal Reserve leaned hawkishly, and the U.S.-China trade war was intensifying. Now, stocks are soaring, the Fed is dovish, and the trade war is not over but some resolution seems near. With the stock market's breakout to new highs, it seems likely that this bull market is beginning another leg higher. This article will examine parallels between this nascent advance and previous, multi-month rallies.
Examining Bull Market Pauses
Taking a long-term view of the S&P 500
In between these advances have been extended periods of range-bound trading. For example, the S&P 500 topped out around 1,370 in May 2011. It didn't decisively break out, until December 2012. During these 19 months, the Fed went from ending QE to launching an even more aggressive form of QE. There were also fears of a "double-dip" recession, and sovereign defaults for European countries with shaky finances like Greece, Spain, Italy, or Portugal.
The stock market had another period of sideways trading from October 2014 to July 2016. Culprits included Brexit fears, slowing economic growth, and plunging oil prices which led to fears of a cascading bust in the energy sector. Cyclical stocks hit multiyear lows, and recession-paranoia began in earnest.
Currently, the stock market has basically been stuck in a range from January 2018 to October 2019. This time, reasons for fear include slowing economic growth, uncertainty and second-order effects from the trade war, and political instability.
Bull Market Advances
In a sense, these pauses are necessary for the bull market to continue for so long. It frustrates impatient bulls and sucks in money on the short side. Money also moves into cash, defensive positions, and bonds. So far, there have been three instances in the past decade when investors positioned themselves for a recession. In 2012 and 2016, they were proven wrong.
It seems likely that they are wrong given that important metrics like the jobs market, housing, and consumer spending show continued upwards trajectory albeit at a slower momentum. This indicates that the US economy was able to absorb a negative economic shock without tumbling into a recession. While the economy continued to grow, monetary policy was significantly loosened in each scenario which also contributed to gains for equities.
In December 2012, stocks broke out as European sovereign bond yields fell back to normal levels with the ECB's decisive declaration that it would "do whatever it takes" to support the Euro. Economic data remained steady, and monetary policy was much looser than May 2011. In July 2016, economic data refuted the recession narrative despite a number of negative shocks. Oil prices were recovering. There was also evidence that the business cycle was turning, following more than two years of a global industrial slowdown.
Currently, similar factors are at play: Politically, the worst-case Brexit scenario is off the table, and the trade situation is improving. Monetary policy is much looser than it was at the previous high. Leading indicators show that the manufacturing sector may be turning.
