Without a 20% correction in the next five months, this current bull market could turn eight years old early next March. This past April it became the second longest on record, though it still trails the 1987-2000 bull run by more than six years. 

That reality alone is reason enough for advisors to check their bearings and assess where the economy and equities are in the cycle. From mid-2014 until last summer the Standard & Poor’s 500 index found itself mired in a range between 1,800 and 2,100. 

Since the Brexit shock and subsequent rally starting in late June, equities have showed signs of breaking out. But a weak economy and uncertainty about politics in the U.S. and Europe, coupled with a profits recession, have limited the advances to 7.8% in 2016’s first nine months.

To sustain a move to the next level, several developments must occur. First, the equity market must shift from an interest rate-led market to an earnings-led variant at a time when profit margins continue to hover near historic highs and are likely to be squeezed by high labor costs.

Many skeptics have labeled the current bull market as a creation of the Federal Reserve and central banks around the globe. At Financial Advisor’s Inside Alternatives conference in Denver this past September, Gluskin Sheff chief strategist David Rosenberg pointed out that the Fed itself has consistently underestimated the weakness of the American economy since the recession ended.

The Fed has relied on models and data developed for other recoveries, but the “near Depression” of late 2007 through the first half of 2009 changed the way Americans save, spend and invest in ways the old models can’t capture. Strikingly, the Fed has overestimated the lone variable over which it exerts total control—the fed funds’ rate. In a similar vein, Wall Street analysts have found themselves repeatedly cutting their earnings estimates in the last few years.

BlackRock’s chief strategist Russ Koesterich noted in early October that stocks can’t count on bonds to propel their next move higher. But while the Fed is expected to raise rates at least once after the presidential election, other events, elections and weak economies in Europe may restrict central banks’ maneuvering room in 2017. Several rate hikes likely would trigger a flood of foreign assets flowing into U.S. Treasurys and other securities, potentially destabilizing the global financial system.

That said, the prospect of future Fed rate hikes has already influenced U.S. equity performance this year, as the favorites of the first half—dividend-paying telecoms, utilities and consumer staples—have retreated since Brexit. Many of these once-loved, low-volatility bond substitutes are down as much as 10% since June.

Some like Jeff Saut, Raymond James’ chief equity strategist, think we are in the middle of a powerful secular bull market. Speaking at a conference in February, Saut said it could take the S&P 500 to 5,400 by 2025. Even to those who agree this is a secular bull, that sounds excessively optimistic since equities would have to produce annualized returns in the mid-teens for nine years to reach those levels.

For an opposing view, one can always turn to the folks at Grantham Mayo, often described as perma-bears. Earlier this year, their respected seven-year model predicted that U.S. large-cap equities would return virtually zero between now and 2022. 

In recent years, Grantham Mayo has maintained that large-cap equities could be overvalued by as much as 40%, attributing half of the valuation excess to unsustainable profit margins and the rest to inflated price-to-earnings multiples. 

Most financial quants would assign low probabilities to either of the outcomes outlined by Grantham Mayo or Saut materializing. Roger Ibbotson, chairman of Zebra Capital, maintains it is difficult to find many seven-year periods when stocks have returned zero.

Ibbotson also notes that equities outperform bonds about two-thirds of the time. In today’s near-zero interest world, it’s difficult to conceive of any environment where most bonds provide investors with any returns like those of the last 30 years.

Cycles Have Lengthened

It’s no secret that since the early 1980s both economic and market cycles have lengthened. Economic recoveries in the 1990s, 2000s and the current decade have all started out at a snail’s pace and only in the 1980s and 1990s did America experience anything like a boom. In those good old days, the economy and equities had a surging bond market as a tailwind.

Other factors besides interest rates are likely to determine which sectors perform well in the next few years. Since this bull market got rolling in 2009, U.S. growth stocks have bested their value counterparts—and foreign markets in general—by a wide margin until this year. 

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