By Charles Hibbert
It is well known around the markets and economy that expansions don’t last long, they don’t die of old age, but that doesn’t mean they can’t get still get slightly weary and last a little longer.
In the eighth year of the current bull market, recent stocks have risen to an all time high, which makes this the second-longest lasting market in history.
However, despite this success, Jonathan Gilonna head of US equity strategy research at Barclays believes that this upswing won’t last long, believing that tradition will strike and the bull market’s old age will die down.
On Wednesday 3 August, Gilonna argued in a note to clients at Barclays that this recent surge wont last forever, saying that while the recent surge has come off strong economic data, it isn’t sustainable enough to push the market even higher for the long-term.
In coming to this conclusion, the strategist analysed three previous late-stage rallies, which took place in 1988-1989, 1998-1999, and 2006-2007 and added this with three conditions that are required to make the market more sustainable.
1. Increasing profit margins: Profit margins in each of the past three late-stage rallies have hit new highs sustaining the rally. Although this time, margins have been on the decline since the third quarter of 2014 meaning the chances of a new cycle high are quite slim.
2. Growing dividends: Dividends from S&P 500 companies have been increasing at a rapid pace in the past three occurrences, “Fast and accelerating dividend growth was present throughout each of the last three prolonged late-cycle rallies. But, dividend growth has begun to slow. We project a six per cent increase in dividends for the S&P 500 in 2016. This is the lowest growth rate since 2010” said Gilonna. A clear slowing pattern is also emerging with forecast ed growth fro the next year being at just 4.5 per cent.
3. Increasing leverage: Leverage is actually increasing, but won’t actually have much more room to grow, according to Gilonna. “While this may be a sustainable amount given the easy conditions and low rates in high grade credit, the days of accelerating growth in borrowings are likely in the past, in our view. This is because some important measures of debt sustainability, such as the ration of debt-to-EBITDA are already elevated.” Essentially, companies are running out of room to borrow any more explains Gilonna.
Each of these trends indicates that companies will continue to grow more in the future. Since the stock market is basically an investment on future expected growth and earnings, investor confidence could be inspires from higher profits, income from dividends or growth through leverage.
Each of these trends though are heading in the wrong direction, which means investors are unlikely to assume that the future of a company is going to be getting better, which in turn means that the stock price is less likely to increase, leading to investor staying out the market meaning the rally dies.
Though this is likely and has happened three times before, those past cycles are not necessarily similar to the current one, as a lot has changed in the markets and economy since the financial crisis.
If we do take evidence based of past occurrences to predict what will happen, the stock market certainly will collapse, but it is still uncertain.