Friday, November 22, 2013

B-U-L-L: Anatomy of a Bull Market

Today’s investors have not seen a bull market in a very long time.  Some have never invested through one at all.  The last time we saw a true bull market was in the 1990s right before the technology bubble of 1999-2000 took hold.  The stock market downturn in 2008-09 was more of a shock-fear reaction to the financial crisis than it was the end of a bull market. 

The market is certainly in a bull market today.  We’ve used the acronym B-U-L-L in the past to describe the characteristics of a bull market and help us understand market behavior.

B- Breadth
Breadth is an indicator of scope or width.  Its application to the stock market is in the range of stocks being affected by overall market sentiment.  In a true bull market, stocks of all types in most every sector are moving higher. 

That is exactly what we are seeing today.  In the last few weeks, the S&P large cap, mid cap, and small cap indices have all hit new highs.  The Dow Jones industrials and Transportations have both hit new highs along with the Russell 3000, which represents the 3,000 most actively traded stocks.  The Cumulative Advance-Decline for NYSE stocks (shown below) is also hitting new highs.

In other words, if you threw a dart and hit a stock, chances are that it is hitting a new high.

The market sees something new on the horizon that it really likes: a better environment for business across the globe.  As we mentioned in previous blog posts, economic growth in all of the major global economies have turned positive and U.S. companies are positioned very well to take advantage of it.  The result has been a series of new highs for the market as a whole as well as the average stock.

U - Unrelenting
A bull market acts very much like its namesake.  Bulls don’t tiptoe around in the China shop and neither do bull markets.  They are unrelenting.  In other words, bull markets will charge ahead and not give you good buying opportunities.

We saw a good example of the market’s unrelenting nature last week when the Dow Jones closed down 160 points.  The very next day, buyers jumped at the opportunity.  In less than 24 hours, the market had made up for the previous day’s losses and then some, closing 10 points higher than the previous day’s close.

L - Leadership Rotating
As we discussed with the term “breadth”, bull markets drive most stocks higher.  However, there are always a handful of market sectors that lead the push higher.  In a very strong bull market, the leading sectors can rotate from one to another without disrupting overall market growth.

To begin 2013, the utilities and consumer defensive sectors drove the market to new highs.  If this was a true bull market, we knew that would change eventually.  In the early part of 2013, we began to shift our portfolios away from defensive sectors into more growth-oriented stocks.  

As we stated in our May 20, 2013 Take Aways, “The market will begin to be driven more by greed than fear.  As that happens, we expect investors to shift their focus from defensive sectors to more growth-oriented, cyclical stocks.”  As we have moved into the latter stages of the year, the defensive and interest-sensitive sectors have indeed taken a backseat to more growth-oriented sectors such as financials, industrials and consumer cyclicals.

L - Loud
Bull markets are very loud.  They grab your attention and force you to take action.  There are plenty of people who have been out of the stock market.  At some point, those who have missed out on the run are going to review their portfolios and realize just how wrong they have been.  Mr. and Mrs. America are going to get tired of less-than-1% CDs and 2.5% U.S. Treasury bonds.  Dividend stocks paying 2.5% and growing 8-10% are a much better alternative.

Bull markets typically turn into bubbles when valuations become extreme and investors become overly optimistic about future stock market returns.  We’re not there yet.  With earnings multiples still well within their historical ranges and in the absence of a viable fixed income alternatives; this stock market is far from a bubble and far from its end.