Stocks Will Likely Move In A Volatile, Sideways Pattern
While bear market bottoms are usually V-shaped, bull market tops typically progress in long saucer-shaped patterns. And we think it is possible we are in the peak of the bull market.
Remember that the S&P 500 Index first reached the 2,950 level in January 2018, before hitting it again last fall, in early May 2019 and a few weeks ago.1 Over the past 18+ months, we have seen high levels of volatility without real upward progress. And almost all other broad-based U.S. and global equity market indexes (including the equal-weighted S&P 500) are lower over that same time period.1 In our view, this accurately describes the top of a bull market.
Market fundamentals, monetary policy, market valuations and investor sentiment are all mixed and seem to be deteriorating. It’s very possible that markets will again return to the 2,950 level once again (or several times). But it is feeling like prospects for a significant and prolonged upside breakout are diminishing with the passage of time.
We may not see significant downside action in the markets any time soon, but at some point the business cycle will mature and the current economic expansion will come to an end. When the next recession does come (our best guess is at some point in 2021), we will almost certainly see an accompanying corporate earnings decline and equity bear market.
As such, we think the risk/reward tradeoff for stocks is neutral in the near term and will eventually become more negative. This suggests a cautious approach toward equity markets.
What does that mean for investment positioning? First, it remains critically important to be nimble and remain highly selective. In most cases, defensive and growth areas of the market are a natural choice in the later stages of a bull market.
But defensive stocks are quite expensive, as are many of the mega-cap growth stocks that dominate indexes and ETFs. We think investors should thread the needle by focusing on soft cyclicals with improving prospects and strong cash flows, as well as on unexploited growth stocks with reasonable valuations.
We think the risk/reward tradeoff for stocks is neutral in the near term and will eventually become more negative.
Robert C. Doll, CFA, is chief equity strategist and senior portfolio manager at Nuveen.
1 Source: FactSet, Morningstar Direct and Bloomberg