Stock Market: Will The Bull Survive?

(Drivebycuriosity) - We are experiencing one of the largest bull markets in history. Since spring 2009 the US stock market gained about 300%. But there are three headwinds: Rising interest rates, climbing oil prices and Trump`s trade war. In the past interest rates, oil prices and trade wars each had started recessions and bear markets. Will the bull market survive this time?

                                                                  (visualcapitalist)



I am still optimistic. The rising interest rates are a response to a growing global economy & climbing company earnings. After the recession 2008 interest rates have been cut to zero and below (negative interest rates). Now they are coming back to a normal level. History shows that stock prices & interest rates can happily rise together: The Bank of America Merrill Lynch (finance) notices that “the 1950s was a period of higher stock prices and higher US interest rates. The US 10-year yield bottomed near 1.5% in late 1945 and the S&P 500 remained firmly within its secular bull market until yields moved to 5-6% in the mid 1960s. The S&P 500 rallied 460% over this period.”

The climbing oil prices are causing headaches indeed. Nine out of ten of the U.S. recessions since World War II were preceded by a spike up in oil prices, writes Prof. James D. Hamilton, University of California, San Diego ( pdf econweb). Another study by Prof.  Hamilton shows that the oil price shock from 2008 - from summer 2007 through July 2008 the oil price spiraled from about $50 to $147 -  turned the economic slowdown into a severe recession (econbrowser).: "The oil price increase over 2007:H2-2008:H1 should be regarded as a key development that turned the slowdown in growth into a recession" (archives).

But the recent economic upswing and the current bull market survived oil prices around $120 in the years 2012 through 2014 and today we are still far below this level. I doubt that we will reach prices beyond $120 any time soon. The US oil production is rising thanks to fracking and the global oil demand is getting curbed by the technological progress which raises the energy efficiency of cars and other machines.

I think that Trump´s trade war against China is the greatest challenge for the economy and the stock market. But I also believe that - if this trade war escalates - it might cause a correction (stocks falling at least 10% from the peak) but won`t start a recession and a bear market (stocks falling at least 20%). A trade war is already partly priced into stock valuations. Even though the US economic growth is accelerating and company earnings grew in the first quarter 25% from the same period last year the US stock market is stagnating (nasdaq).

I think there are enough tailwinds which should overcompensate the negative impulse of a trade war on the US economy and stock market. The strong earnings growth, the engine of the bull market, will continue trade war or not. A part of the earnings growth is the result of the recent tax cuts of the Trump administration, about 7 percentage points estimates LPL research, which reduces the (basic) earnings growth rate to about 18%. I think that company earnings will continue to grow with double-digit rates because fast rising company earnings are a long term trend. Corporations are getting more efficient & more productive over time - thanks to learning processes and the technological progress.  During the recession 2008 companies had restructured and reduced costs significantly in order to survive. Now they are more fit & more efficient than before.

Company earnings are also boosted by automation. Since the early 18th century (the first industrial revolution) the technological process has been enabling companies to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs, higher profit margins and climbing earnings. We are experiencing a rapid advance of information technology, meaning combinations of computers, smartphones, Internet and other digital systems. Software - which is increasingly Internet connected and uses more and more the cloud (access to huge external data centers) - organizes the whole business: Creating new products, inducing machines to run more efficient, finding cheap suppliers, manage customer relations and so on.

The US economy is very robust, driven by a strong job market and rising retail sales. The economy is also boosted by the recent tax cuts and the ongoing deregulation of the American banking sector. I assume that the current bull market will continue for years to come fueled by the technological progress and climbing company earnings.