- Many measures of investor sentiment indicate widespread uncertainty about the direction of markets.
- The age of the bull market, U.S. elections, the possibility of a mistake by central banks, U.S. dollar strength, Brexit, and China’s debt problems all seem to have the potential to scare markets.
- Looked at in context, the current “wall of worry” is not unusual, and we believe the bull market will continue into 2017.
It’s Halloween, so what else could we do but write about what might scare the markets? We know from the financial media, measures of investor sentiment, and mutual fund outflows from equities and into bonds that investor nervousness is widespread. Some concerns are related to the presidential election, now just eight days away. Other concerns are related to the age of the bull market, discomfort with central bank actions, Brexit, and China’s debt problems; and there are certainly others. This week, in the spirit of Halloween, we discuss what might scare markets.
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SCARE #1: AGE OF THE BULL MARKET
The bull market and the current economic expansion are now seven-and-a-half years old, and are as long as any post-WWII cycles besides the 1990s. Some market participants believe this alone means that the U.S. economy will likely head into recession next year, ending the current bull market. But bull markets don’t die of old age; they die of economic excesses. Essentially, the gradual trajectory of the economic recovery from the Great Recession increases the chances that the expansion lasts longer.
We continue to follow a variety of leading economic indicators and are closely watching for signs of overheating in the economy that might suggest a recession is forthcoming. The latest reading on gross domestic product (GDP) for the third quarter of 2016 increases the odds that the expansion continues. The categories of excesses that have ended prior economic expansions and bull markets (overspending, overborrowing, overconfidence) remain contained. Bottom line, based on the indicators we watch, we see a low probability of recession in the next 12 to 18 months (perhaps 20%), although there is always the chance of an exogenous shock or policy mistake.*
*LPL Research is always on recession watch and we use our Five Forecasters as the advance warning system. These five data series have a significant historical record of providing a caution signal that we are transitioning into the late stage of the economic cycle and that recessionary pressures are mounting. Specifically, we monitor: the Market (using the treasury yield curve), Fundamentals (using the Index of Leading Economic Indicators, or LEI), Valuations, using the S&P 500 trailing price-to-earnings ratio, Technicals, using market breadth, and Sentiment, using the Institute for Supply Management’s Purchasing Managers’ Index, PMI.