Stock prices have been rising for more than eight years, but bull markets don’t die of old age. There are few signs of the excessive growth, excessive valuation or excessive financial leverage that usually signal the approach of a bear market. The world economy is picking up but wage inflation remains muted, despite low unemployment rates.
Central banks are reluctant to tighten policy in a meaningful way. With interest rates below the rate of inflation, it is unsurprising that money continues to flow into markets.
Some market commentators are alarmed each time stocks reach new highs, but this betrays a lack of historical perspective. Long-run data show US stock returns with dividends reinvested averaging around 7% a year in real terms. Occasionally, markets reach the top of the return channel, as happened in the late 1960s and again in 2000, and future stock returns disappoint for around a decade. The bottom end of the channel was reached in 2009, and markets have spent most of the last eight years below the previous upper limit. As things stand, the bull market is expected to continue for at least another year or two.
At some point a sustained rise in inflation will trigger a concerted effort by central banks to tighten monetary policy. Rising bond yields and, ultimately, a rolling over in global growth will lead to losses in stock markets. Though investors are attune to this risk, wage pressures remain surprisingly muted. Similarly, a multi-year economic slowdown in China is likely to keep commodity prices under control.
The Investment Clock model that guides Royal London’s asset allocation is back in the equity-friendly ‘recovery’ phase, a mid-cycle configuration with growth picking up and inflation dropping. Central banks in the US and UK are inching towards tightening, but meaningful increase in interest rates is not expected against this backdrop.
Trevor Greetham is head of multi asset, Royal London Asset Management.