Christian’s Lie: New Bull Market or Tug of War?

The value of global stocks, measured in krone, has risen more than 20 percent this year. About half of that number is due to the weakness of the krone and a large proportion has to be attributed to a handful of US tech companies that are riding a wave of optimism about artificial intelligence. It’s a volatile market climate, with both optimism and pessimism. I summarize and rest my head on the block for a bit.

About bull and bear

Butting an angry bull can give you a boost at first. A teddy bear that lands on the wrong paw first will quickly send you onto the field. According to Hamar-based ChatGPT, this is the scientific explanation for why strong rises in stocks are called bull markets, and declines are called bear markets. Some have found that the difference between the animals is respectively 20 percent higher than the bottom and 20 percent higher than the top. Whether we measure in dollars or kroner, the rally level for global stocks has been exceeded since the turning point in October. Does this mean that the bear market from 2022 is now over, and that we can celebrate with red wine and beef jerky?

For if he was deceived, we have been deceived for an abnormally long time

Historically, it has been common for small and large periods of a bear market to have rebounds, the so-called “bear market highs”. If we are still in a “structural” bear market, based on US data since 1950, it has never included such a long rally as we have now. However, the fact that rates are up more than 20 percent from the bottom is no guarantee of new bear visits. However, it is reassuring that every time US stocks rise 20 percent from the bottom, prices will continue to rise over the next 12 months in 92 percent of the cases, according to Bank of America.

Arguments that a bull market can continue

Weak growth, but no deep recession? Even after sharp increases in interest rates and prices, the major economies have not hit a wall. In the eurozone, the economy has certainly been in a slump for the past couple of quarters, and the global economy is by no means booming, but with good help from the service sectors, GDP is now running at 2.4 percent, according to Goldman Sachs. On average, economists expect a growth rate of 2.6 percent this year and 2.7 percent in 2024. This compares to average global GDP growth of approx. 3.5 percent over the past 40 years. Financial markets don’t necessarily need high economic growth to generate good returns, but they falter quickly if recession fears take hold.

Even if interest rates are kept high in the coming quarters, lower inflation will contribute to higher real wage growth for households, supporting spending power. A survey conducted by Deutsche Bank showed that nearly a third of respondents believe that the slowdown in the US economy will be so mild that it will have little impact on financial markets. Arguments for a moderate downturn are a gradual decline in labor markets, lower inflation and wage growth, that interest rates will peak soon, as well as stronger individual and corporate balance sheets than they were before the financial crisis.

Profitable business growth? After a period of lower earnings expectations, the trend has reversed. Global earnings growth is expected by only 0.8 percent in 2023, but estimates for 2024 come in at 10.9 percent. Although this may sound optimistic based on the lower expected GDP growth, the slightly positive profitability development will support the financial markets. If oil, raw materials, and shipping prices remain low, and the dollar also avoids a downturn, that will also be positive. Earnings growth may offset good valuations in some regional markets. If earnings rise more than stock prices, for example, your P/E can go down without it implying a negative return.

Extreme pessimism in October. New bull markets often started when pessimism took hold. Risk appetite among private and professional investors was at financial crisis levels last fall. Today, many investors see the outlook as somewhat brighter, but a large survey of managers shows the mood remains cautious. That the gains in US stocks this year have been largely driven by computer strategies testifies to the fact that many human investors have the potential to invest more if uncertainty eases further.

Arguments that we are not done with the teddy bear

What are the typical characteristics of past economic booms and emerging markets, and what is the situation today?

Any acceleration in the economy will quickly be able to meet capacity challenges in terms of, for example, work. This may lead to new inflationary pressures and raise new interest rates. Valuing stocks and corporate bonds today leaves less room for future increase (expansion multiple), so a greater proportion of the return depends on the company’s earnings. Low rather than high profit margins will provide a better starting point for this.

Anxiety evident beneath the surface. Globally, the IT sector (the top three are Apple, Microsoft, and Nvidia) and non-core consumer goods (the two biggest are Amazon and Tesla) are up 30 and 20 percent, respectively, since the start of the year. Of concern remains the energy sector (down 5 percent in dollars), renewables (down 10 percent) and telecoms (down 3 percent). Health, supplies, possessions and finances have also decreased somewhat. In the US, seven stocks have led the stock rally this year alone.

The risk of recession remains

Neither the valuation nor the earnings forecast specifically reflects the possibility of a major economic setback. The US stock market in particular, which makes up 62 percent of the global stock market, is priced as high as 19 times expected earnings. If you exclude the 50 largest companies in the S&P 500, the rest are priced at 15 times earnings. That’s below the historical average, but higher than a pandemic P/E of 11 and a financial crisis P/E of 10.

Fixed mortgages, companies that took advantage of the zero interest rate system to borrow money at long maturities, savings more than usual and strong demand for services helped keep consumption and employment in Western economies. If interest rates are kept high through 2024 and/or interest rates rise further, more households and businesses will have to refinance at much higher interest rates. It could become the tip of the balance for rising unemployment and a recession that erodes profits and the ability to service debt.

Bull and bear into each other?

I think interest rate cuts in the US or the Eurozone are unlikely without significant weakness in the labor markets. Layoffs appear to be sticking around longer for employers today than they did before the pandemic, which is reflected in the strong US job numbers. However, the fact that the economy is weakening can be seen by the fact that the average working hours per employed person per week has fallen to the level of April 2020. The result may be that unemployment in many countries will rise less than in previous economic downturns. This can support consumer capacity and help avoid a deep self-reinforcing crisis.

If things go better than expected, it will run counter to the ambitions of central banks to tighten the conditions of the fiscal framework, lower wage growth and lower inflation. The result could be higher interest rates. On the other hand, if things are worse than expected, central banks can indeed cut interest rates (which is already expected in financial markets), but then valuation and earnings estimates look very optimistic.

If a serious recession is avoided, there are good chances of weak but positive growth in the economy and in the company’s earnings. At the same time, it could lead to a higher natural level of growth in wages and interest rates, as well as limit the potential for inflation-adjusted returns in financial markets in the coming years.

Without a “little” crisis and panic, we don’t go back “to the beginning” in my hypothetical table. In the absence of a clear starting point for a strong bull or bear market right now, we should prepare for a turn in the tug-of-war. This adds to the importance of several good building blocks in the portfolio, as well as the long horizon for investments. The tide probably won’t lift all boats at the same time.