Why the Bull Market Could End in 2020

By Ben Levisohn                      

All of us, at some point, must confront our mortality. So, too, must investors prepare for the demise of a bull market that began in the depths of the financial crisis in 2009.

Yes, predictions of the end of this record run have been made before—and have been proved wrong.

The rally has so far seemed almost indestructible, thanks to stable economic growth and the Federal Reserve’s easy-money policy. 

But many market strategists and economists see powerful forces converging that could finally trip up the bull. For one, the economy has been juiced by the tax cuts and fiscal-spending package that Congress passed at the end of 2017—a stimulus that should last another year or so. Just as its effects are fading, the Fed will be continuing to push interest rates higher and shrinking its $4 trillion balance sheet.

Put them together and you have a drag big enough to slow the economy, while stamping a bright expiration date on the bull market: 2020.

And it isn’t just permabears who are gloomy of late. Ben Bernanke, the former chairman of the Federal Reserve, recently said that after two years of stimulus, “in 2020, Wile E. Coyote is going to go off the cliff and is going to look down.”

Even less-pessimistic economists and market watchers acknowledge that economic expansion will slow in 2020, while corporate profits, though still increasing, will do so at a slower pace than they had previously. Global economic growth could also feel the pinch if the European Central Bank begins raising interest rates toward the end of 2019, as it has suggested it might. These conditions are far different than what has existed in the bull market.

There’s no denying this one is getting long in the tooth. The average postwar bull market gained 161% over 1,821 days. This one, at 3,400 calendar days, is already the second-longest on record, lagging behind only the 4,494 days during the marathon run from 1987 through the peak of the tech bubble in March 2000. The S&P 500 has gained 302% since its bottom in March 2009, the second-longest run on record. During the 1987-2000 bull, the S&P 500 rose 582%. And while bull markets don’t die of old age, each day brings a reckoning that much closer.

“Like the human body, the market becomes less resistant to shocks and viruses the older it gets,” says Christopher Smart, head of macroeconomic and geopolitical research at asset manager Barings.

While a correction from its Jan. 26 highs has removed some of the market’s most egregious excesses, signs of investor complacency abound. The Cboe Volatility Index, also known as the VIX, remains below its long-term average around 20 times, and investors continue to put money into mutual and exchange-traded U.S. stock funds, even as they have fled other markets. And for investors betting that the diversity of their index ETFs will save them, the Leuthold Group’s chief investment strategist, Jim Paulsen, notes that the weight of defensive sectors in the S&P 500 has dropped to 15%, an all-time low. “Investors should be aware that defense has left the building,” Paulsen warns.

If nothing else, it’s time for investors to think about the types of companies they own, and to begin shifting away from the riskiest and most indebted toward those better-positioned to withstand a downturn. And while it may reduce short-term returns, there’s nothing wrong with holding a little extra cash to tamp down a portfolio’s volatility and deploy when stocks do fall. Because the market always falls, eventually.

To understand why 2020 should loom large in investors’ vision, keep in mind the reasons that the past nine years have been so good. Some might call post-financial-crisis growth in the U.S. lackluster; it has also been remarkably consistent, never climbing by more than 2.9% or by less than 1.5% in any calendar year since 2010. And inflation has been subdued, as well, creating the Goldilocks environment that was neither too hot nor too cold.

The latest fiscal stimulus—the tax cuts—changes that. Congress passed $1.5 trillion of them over a 10-year period, while also increasing spending by some $300 billion over two years. The Peterson Institute for International Economics puts the total impact at an additional 0.5% of gross domestic product by 2020.

Companies have used that cash to repurchase shares, increase dividends, buy competitors, and invest in their businesses. All of that activity looks set to have a big impact, though the question remains how big. Economists expect the U.S. economy to grow at a 2.9% clip in 2018, up from 2.3% in October. And that economic growth has also translated to a big boost in earnings projections, as corporations are expected to see profits rise by 21% in 2018 and 10% in 2019.

Like any artificial high, the good feelings won’t last forever. By the end of 2019, the last of the fiscal intoxication should have worn off, and the hangover could begin. Economists expect the U.S. economy to expand by 1.9% in 2020, and earnings to increase by 10%.

“The tax stimulus is designed to be very front-loaded in the lift it gives to economy,” Morgan Stanley chief U.S. economist Ellen Zentner says. “You have to deal with the hole on the other side.”

The stimulus, however, isn’t occurring in a vacuum. The Fed is already raising interest rates, and is doing so at a faster pace than some investors had counted on. At its current pace of a hike every three months, the federal-funds rate should hit a range of 3.25% to 3.5% by the end of 2019, up from 1.75% to 2% currently.

At the same time, the Fed is shrinking its behemoth balance sheet. That means monetary policy could be hitting its tightest levels just as the impact of the government stimulus begins to wear off.

Alan Ruskin of Deutsche Bank argues that fiscal stimulus has restored the “arc” to both the economy and the policy cycle. The arc refers to the rise above trend growth, followed by the decline back below it. The arc of economic growth is also mirrored in monetary policy, which should follow the same path as the economy strengthens, and then weakens.

That arc, however, is nowhere in sight. The Fed’s “dot plot,” which tracks where each member of the Federal Open Market Committee thinks rates will be over three years, suggests that fed funds will hit 3.25% to 3.5% before a gentle easing. The market, meanwhile, is pricing in rates hitting 2.6% at the end of 2019 and going sideways from there. Those paths are unlike any seen before. “What’s priced in has no modern monetary policy precedent,” Ruskin says.

Market indicators are also pointing toward 2020 as a year of reckoning for the stock market. Look no further than the so-called yield curve—that is, the difference in returns between short- and long-term Treasury securities.

In good times, the longer-term yield should be higher than the shorter because it means a bank can borrow at the lower short-term rate and make money lending at the higher longer-term one. When short-term yields rise above long-term ones, there’s no incentive to lend, and that “inverted yield curve” has typically preceded a recession by six to 24 months.

The yield curve hasn’t inverted yet—but it’s getting close. The two-year Treasury’s yield was at 2.524% on Friday, while the 10-year’s was at 2.844%. That 0.3195 of a percentage point difference is the narrowest since the financial crisis ended. If the Fed continues to raise rates at its current pace, the yield curve is likely to be flat by year end, says David Ader, chief macro strategist for Informa Financial Intelligence, and to invert during 2019’s first half. “That would point to recession in the second half of 2019 or early 2020,” he explains.

An inverted yield curve acts as a market signal, as well. Charlie Bilello, director of research at Pension Partners, notes that since 1956, the S&P 500 has dropped an average of eight months after an inversion of the one- and 10-year Treasury yields, though it took 21 months from an inversion in 2006 to the stock market’s peak in 2007. “That’s a long time to wait, exposing just one of the problems in using the yield curve to time your stock market exposure,” Bilello adds.

While 2020 may be pointing to the edge of a cliff, a lot could happen by 2020 that could either extend the cycle, or end it sooner.

The brewing trade war between the U.S. and its trading partners is the most obvious, as escalating tensions could negate the stimulus boost—and cause a selloff long before a recession. The S&P 500’s 2.2% decline during the past two weeks suggests that these worries are already having an impact.

On the other hand, the Fed might decide it would be better off slowing rate increases in light of global tariff turmoil. There’s even a possibility that the economy, which has survived so much since 2009, just keeps soldiering on—and lifts stocks with it.

“The bull market will last as long as the economy expands,” says Ed Yardeni, chief investment strategist at Yardeni Research. “I don’t know anything today that leads me to put a time frame on when this bull market ends.” That means stocks’ path to 2020 could be as rocky as 2018’s has been, or that equities could see one final melt-up before it all comes crashing down.

Investors need strategies to handle both potential scenarios.

The best way to do that could be to focus on high-quality stocks, says Brian Belski, BMO Capital Markets’ chief investment strategist. He defines quality stocks as those with an investment-grade credit rating, lower earnings-growth volatility than the S&P 500, higher return on equity than the median stock in the benchmark, and a larger-than-average cash position.

Such shares have performed quite well in all market periods. High-quality stocks have averaged a 13% gain annually since 1990, versus 7.7% for the S&P 500, according to Belski’s data. And they’ve fared even better in rocky markets with above-average volatility, rising an average of 4.2% annually, compared with 2.9% for the S&P.

“Our work suggests these stocks not only are well suited for volatile market periods, but also are an attractive long-term investment strategy,” Belski says. “As such, we believe it would behoove investors to focus on this sort of strategy as markets continue to digest what has become an increasingly complicated investment landscape.”

Stocks that meet Belski’s requirements include exchange-traded fund titan BlackRock (BLK), biotech giant Biogen (BIIB), Costco Wholesale (COST), and United Technologies (UTX).

In a similar vein, David Kostin, Goldman Sachs’s chief U.S. equity strategist, has been recommending stocks with strong balance sheets, which tend to outperform when the Fed is raising rates and monetary conditions tighten. That should pay off, regardless of whether the economy continues to expand at a strong pace, or if growth slows and heavily indebted companies struggle to cover their interest payments, Kostin observes.

“Strong balance-sheet stocks appear primed for outperformance whether economic growth remains strong or falters,” he explains. Stocks included in Goldman’s Strong Balance Sheet Basket include Facebook (FB), Intuitive Surgical (ISRG), Monster Beverage (MNST), and Verizon Communications (VZ).

But it also pays to remember that bear markets are inevitable—and not the worst thing that can happen, as long as an investor is prepared. The S&P 500, after all, dropped 57% from peak to trough during the financial crisis, but investors who held on through it had recovered their losses by the end of March 2013. The worst damage was suffered by those who couldn’t take the pain and sold near the bottom; they never made their money back.

For investors who may not have the fortitude to hang on through a run-of-the-mill correction, let alone a real bear market, Michael O’Keeffe, chief investment officer and head of investment strategy at Stifel, recommends holding a bit more cash. “Sell a little bit of your equities, and hold more dry powder,” he advises. “When the move occurs, you’re ready to redeploy.”

That sounds like good advice, especially now that it’s possible to get close to 2% on cash, a big increase since we last took the temperature of this bull market 10 months ago. With the market even longer in the tooth, that doesn’t look too shabby.

The Transatlantic Rupture

Dominique Moisi

Belgium NATO meeting

PARIS – The national park of Thingvellir, 30 miles east of Reykjavik, is Iceland’s most important historical site. It is the place where the Vikings founded the first democratic parliament in 930, and where the Republic of Iceland proclaimed its independence from Denmark in 1944. It also sits on a massive geological fracture, where the small Hreppafleki plate forms a narrow rift between the tectonic plates of North America and Eurasia. In the current geopolitical environment, the symbolism is potent.

No doubt, there is a rift between the United States and Europe. The Hreppafleki plate can represent China, which has reclaimed its position in the top tier of global powers – a situation to which the US and Europe cannot seem to agree on a response. Or perhaps it is more accurate to have Hreppafleki represent US President Donald Trump, whose repeated provocations – including with regard to China – have depleted transatlantic goodwill, while undermining America’s role in the world.

The Cold War, from 1945 to 1989, was characterized by a bipolar world order in which stability depended on a balance of nuclear terror. After 1989, a more hopeful order emerged, led by a hegemonic US, though it was still destabilized by forces like international terrorism. But we have now entered a new phase, in which the US is actively alienating the rest of the world, by violating norm after norm.

In recent weeks alone, Trump imposed massive import tariffs not only on China, but also on America’s Asian and European allies; disrupted the G7’s annual summit, accusing America’s closest allies of unfair trade practices; and then met with Kim Jong-un in Singapore, where his insulting behavior toward America’s European and Canadian partners gave way to effusive praise for North Korea’s brutal dictator. And he launched (and, under political pressure, rescinded) a cynical policy of separating migrant children from their families at the southern US border.

In short, Trump has summarily divorced his allies, in political and emotional terms, as he has attacked the values on which democracy depends. In that sense, this moment amounts to the precise antithesis of the autumn of 1989, when the Soviet bloc began to collapse and democracy seemed triumphant. Now, it is not clear what the US stands for, and that uncertainty puts the entire transatlantic alliance at risk.

To be sure, this is not the first time transatlantic relations have come under strain. In the early 1960s, French President Charles de Gaulle rejected a key pillar of the relationship, NATO, by incrementally reducing France’s military and political participation. Whereas US President John F. Kennedy presented NATO as a shared roof supported by two pillars – the US and Europe – de Gaulle viewed it as a mechanism of US hegemony. In any case, France’s withdrawal from NATO did more to isolate the country than to weaken the transatlantic Alliance.

The relationship was challenged again in 2003, when France and Germany, among others, refused to join the US and the United Kingdom in the (ill-advised) invasion of Iraq. But, again, the survival of the transatlantic alliance was never in doubt.

The difference today is that it is the US that is pushing back against the alliance – if not the entire Western liberal democratic model. A sheep gone astray is one thing; if the shepherd leaves, the entire herd is at risk. Yet, as “America First” becomes “America Alone,” that seems to be precisely what is happening.

But Trump risks overplaying his hand. America’s power relative to other countries has reached its postwar nadir. With the world becoming increasingly entrenched in a multipolar order, the US can hardly afford to dispense with allies.

Of course, that is not what the Trump administration sees. The president and his allies remain convinced that hard power is all that matters; and, from a military perspective, the US remains the top dog. But this dominance is not guaranteed to last, especially in the face of massive Chinese military investment. More important, hard power alone is not enough to sustain alliances, much less exercise global leadership.

Trump seems unlikely to recognize this and change course. But even after he leaves the White House, a return to “normalcy” is not assured. While Trump hardly represents all of American society, we should not delude ourselves: his victory was no accident. There was – and still is – an appetite for unilateralism and isolationism among American voters. That will not disappear from US politics, even after Trump does.

America’s traditional allies therefore cannot simply wait Trump out; instead, they must adjust to today’s reality. In the past, Europeans often diminished the value of geography, which would have demanded a closer relationship with Russia, in favor of the geography of values, which justified a transatlantic orientation.

When the US is led by an administration that is betraying those values – going so far as to rip children from their parents and put them into cages – that argument no longer applies. The only way forward is to stand up to the US in defense of our values and interests.

Trump may be good at mobilizing his base at home or connecting with ideological “friends” abroad. But, without the support of its true allies, America’s global influence will only deteriorate further. From a geopolitical perspective, that approach can produce only one result: “Making China Greater Faster.”

Dominique Moisi is Senior Counselor at the Institut Montaigne in Paris. He is the author of La Géopolitique des Séries ou le triomphe de la peur.

Mama’s love

China starts easing monetary policy. Or does it?

The challenges of interpreting the central bank’s latest move

CHINESE investors often refer in jest to the central bank as “central mama”. The idea is that it can be counted on to provide tender love—that is, policy easing—when market conditions are rough. But during the past couple of years it has been more of a disciplinarian, taking cash away from reckless investors. Its latest move, a cut of banks’ required reserves, has triggered a debate about which school of parenting it subscribes to these days. Is central mama turning soft again, or is she still cracking the whip?

On June 24th the People’s Bank of China said it would reduce the portion of cash that most banks must hold in reserve by 50 basis points. This was equivalent to deploying 700bn yuan ($106bn) in the financial system, or nearly 1% of GDP, which might sound like a healthy dose of liquidity to shore up growth. But the central bank insisted that it was not easing policy.

Many analysts take the central bank at its word. In the past, when it focused on the quantity of money in the economy, reducing required reserves could be seen as a form of loosening. But in recent years it has placed more emphasis on interest rates. Its most important target is banks’ short-term cost of borrowing from each other. That remained stable over the past week at about 2.8% in annual terms, proof that the announcement had little discernible impact.

Moreover, the main weapon in the central bank’s arsenal this year has not been monetary tightening but stricter regulation. It has, for example, forced banks to bring off-balance-sheet loans onto their books. There is no sign that officials are about to reverse these policies, which are at the heart of their campaign to rein in debt. E Yongjian of Bank of Communications, a Chinese bank, says cuts in required reserves can, over the long term, be viewed as policy normalisation. China used to rely on reserves to neutralise the inflationary effect of money flowing in from its whopping trade surplus. Even after the latest cut, banks must park 15.5% of their assets at the central bank as reserves, earning meagre interest. But with China’s current-account surplus steadily shrinking, the central bank has started to release this pent-up liquidity.

The counterargument is that, despite the central bank’s protests, the timing and manner of these cuts matter. The latest move stood out. In April it also cut the reserve requirement ratio, and by twice as much: 100 basis points. Yet that was more of a technical adjustment. The cash injection was mostly cancelled out by the central bank’s withdrawal of liquidity from another channel. This time, all of the 700bn yuan freed up was available for banks to use. The central bank specified that it wanted them to step up the pace of swapping corporate loans into equity stakes (part of China’s strategy for paring its debts). But as Julian Evans-Pritchard of Capital Economics, a consultancy, notes, this amounts to a “convenient excuse”, allowing China to inject large amounts of liquidity without abandoning its commitment to tackling financial risks. Analysts with Nomura called it a “clear signal of policy easing”.

The stockmarket, in so far as rationality can be ascribed to it, came down on the side of those saying that the central bank has not really started to ease. Prices continued to fall, taking the benchmark Shanghai index down more by than 20% since January. Technically, that makes this a bear market. Should the tumbles continue, it may not be long before central mama puts her more indulgent side on full display.

Global Debt Is Weighing On Gold Prices

By Arkadiusz Sieron


In the latest edition of the Market Overview, we have analyzed the risk related to the rising U.S. public debt and private leverage. This month, we will adopt a more global perspective.

Until recently, thanks to the synchronized worldwide growth, it was easy to lose sight of the elephant in the room. But as U.S. interest rates have climbed in recent months the and dollar has appreciated, we cannot ignore the debt threat any longer.

Indeed, the elephant is doing well. It is well-nourished and constantly growing. As the chart below shows, total non-financial debt has risen from 191 percent of global GDP at the end of 2001 to 210 percent before the financial crisis and to 245 percent today (the most recent data are for the end of September 2017).

Chart 1: Credit to non-financial sector from all sectors at market value as % of GDP from 1990 to 2017.

So much for deleveraging. Or actually there was a deleveraging. When you decompose the total debt, you will see that households have reduced their debt burden after the Great Recession (although it bottomed in March 2015). What happened was the increase in corporate indebtedness and even higher spike in the governments’ obligations, as one can see in the chart below.

Chart 2: Credit to general government (blue line), to households (green line) and to non-financial corporations (red line) as % of GDP from the end of March 2008 to the end of September 2017.

And that trend is set to continue, as populist agenda has been absorbed into mainstream politics. All you need is to look around, the post-recession austerity is dead. Although the macroeconomic conditions seem to call for budgetary prudence and fiscal tightening, the politicians loosen fiscal policy. The best example is the U.S. public debt, which is likely to reach about 108 percent of the GDP this year, despite the growth pickup. Not to mention Japan, where the debt-to-GDP ratio is above unbelievable 250 percent.

Everyone who endured the economic crises knows that high debts create serious risks, as credit-fueled booms are clearly not sustainable in the long-run. Hence, if policymakers do not make fiscal consolidation and do not implement structural reforms, something bad may happen when the good times pass away. The wolf does not need much to blow down pigs’ houses made of straw and sticks. Just one puff. It’s not hard to imagine an external negative shock to the global economy in our times. Just one tweet. And the house collapses and the wolf comes in. Gold should shine then.

Surely, the global economy recovered after the financial crises, but – as Carmen Reinhart noticed – “recovery it’s not the same as resolution.” Many fundamental problems – such as excessive leverage, weak banks with non-performing loans, slow productivity growth or rigid markets have not yet been solved. Instead, the ultra low interest rates eased the pain. But the yields are on the rise. The U.S. dollar has been appreciating recently. The example of Argentina clearly shows that emerging economies are still vulnerable to sharp and sudden appreciation of the greenback.

However, the near future is not so gloomy. All too often analysts focus on simple aggregate debt figures. Let’s take China’s total debt which is expected to reach 260 percent of GDP at the end of this year. The aggregate number seems to be scary, but about two-thirds of the private-sector debt, which constitutes the majority of total debt, is held in renminbi by state-owned enterprises and local-government entities. Hence, the debt crisis in China is not as likely as many people believe. Or let’s take Greece. The country is heavily indebted, but it pays lower interests than other countries, since the debt is held by public institutions and its maturity is very long. Or Uncle Sam. It adds fresh obligations to its big pile of debt, but the uptick in economic growth should cushion the blow.

The take-home message is that gold bulls shouldn’t count on the outbreak of the next debt crisis anytime soon. Fair enough, the global pile of debt is staggering. And the rise in yields and in the value of the U.S. dollar will only deepen the problem of excessive indebtedness, especially for emerging countries. However, the interest rates have been climbing gradually, which softens the hit. And, we are sorry to say that, but the economic problems of emerging markets are not a huge problem for global financial system. Gold will not benefit from their misfortune. On the contrary, capital flows from emerging economies into the U.S. will additionally strengthen greenback, putting the yellow metal under pressure.