Financial markets on Wall Street have experienced a two-year growth spurt. Sustaining this upward trajectory, is it feasible?
This two-year milestone is famously known in the realm of gift-giving as the cotton anniversary. And given that US currency comprises 75% cotton, merchants are commemorating this occasion with their favorite gift: cold, solid greenbacks.
Since October 12, 2022, the S&P 500 has witnessed an astounding surge, gaining 22% in its inaugural year and an additional 33.7% in its second. The index has now reached an unprecedented 44 record highs, not only bolstering corporate revenues but also enhancing everyday Americans' retirement savings and investments.
However, one may wonder if this festivity can persist?
Defying the odds
A bull market refers to a phase where stock prices increase by minimum 20% after a decline, reflecting investor confidence and expectations of further economic growth.
What makes this bull market exceptional is the plethora of uncertainties and economic apprehensions that investors had to confront throughout its duration. Despite the Federal Reserve's initial interest rate hikes, persisting inflation, and wars in Europe and the Middle East, stocks continued their upward momentum.
Currently, things appear brighter. Inflation and interest rates are on a downward trajectory, while geopolitical dangers persist but are primarily localized. Moreover, election years typically boost US markets.
History also favors Wall Street. Historically, bull markets recoup approximately 194% of the preceding downturn, as per Sam Stovall, CFRA's chief investment strategist. Moreover, since 1950, bull markets have averaged approximately 61 months or about 5 years, excluding the ongoing bull market, as per Adam Turnquist, chief technical strategist for LPL Financial.
Therefore, there may be scope for this celebration to continue - and there are indicators that suggest so.
Corporate earnings are projected to surge in the upcoming year, suggested Quincy Krosby, LPL Financial's chief global strategist, in a note. Consumer spending is still inching up, and the Fed is decreasing interest rates, which should cushion employment statistics. Additionally, the AI revolution has furnished the market with a fresh concentration of robust returns, acknowledged Krosby.
“There’s no compelling reason that this bull should yield to the perpetually lurking bear, particularly with a supportive Federal Reserve, a robust economic foundation, and an earnings growth outlook pointing towards stable development,” she said. “These factors collectively suggest that the bull’s second birthday present is highly promising for another year.”
Back to the bear
However, before Wall Street becomes overconfident, traders should brace themselves for some turbulence ahead. While the first two years of a bull market often witness substantial gains, history indicates that the third year may present challenges, said Stovall. On average, bull markets entering their third year deliver a modest gain of just 2%.
Even more distressing for revelers is that every one of the last 11 bull markets that reached their second anniversary encountered some sort of correction in their third year. All experienced a minimum 5% drop, with five enduring declines greater than 10% but less than 20%, and three ultimately sliding back into bear territory, according to Stovall.
Despite the perils, three of these 11 second-year bulls still managed to yield double-digit returns in their third year, demonstrating that despite a few bumps along the way, profit opportunities remain.
Given the historical trends, investors might consider diversifying their portfolios during the third year of this bull market to mitigate potential risks. Furthermore, careful monitoring of market indicators and economic factors, such as corporate earnings and interest rates, can help investors make informed decisions about their business investments.
