We’re heading into year two of one of the fiercest bull markets in history, and stocks are on fire.
Just look at the scoreboard. The S&P 500 has rallied 75% since the depths of March 2020, heading for its biggest 12-month gain on record.
As we reach the anniversary of the pandemic market bottom, stocks could be nearing an important fulcrum point. Markets and the economy have gone through an unusually swift recovery over the past year following the COVID-19 pandemic.
Embarking on the second year of the current bull market could be just as exciting for investors, but it is easy to question if the strength will continue. Some may wonder if the shortest bear market in modern history could be followed by the shortest bull run.
The latter scenario is akin to the “sophomore slump,” a phenomenon where a performer has a stellar debut, only to follow it up with a mediocre second season. Think of the sports free agent who disappoints after scoring the nine-figure contract, or the sequel that just doesn’t live up to the original.
While we don’t expect this bull market to be a one-hit wonder, at this anniversary we think it’s wise to re-examine our strategy.
Standing at an Important Moment
On one hand, you have robust economic tailwinds:
COVID-19 restrictions are being loosened with vaccines being more widely distributed. As the economy re-opens, the government is still injecting trillions of stimulus dollars into the economy and on Wednesday, the Federal Reserve reiterated its pledge to keep short-term interest rates at or near zero into 2023.
All that adds up to an environment where gross domestic product growth could be approaching the high single-digits by the end of this year. As a result, it should come as no surprise that investors of all sizes are excited about the prospects for 2021 and beyond.
But on the other hand, many market experts point to high valuations as a concern. As the S&P 500 approaches 4,000 for the first time, the index is valued at 23x expected earnings over the next four quarters, which is toward the high end of the historical range. Inflation expectations are rising, making it harder to justify high valuations, and the notion of fair market value has a psychological impact as well. Don’t you prefer to buy items at a discount rather than overpaying when you shop?
While overall market valuation should come down to reality as earnings improve, valuation is a real risk in high-flying sectors. The appetite to pay increasingly high prices for future growth, particularly for companies that don’t yet generate meaningful cash flow, could continue to diminish.
We’ve already seen that to some extent in early 2021, as the stodgy Dow Jones Industrial Average has returned to record highs, while the tech-heavy Nasdaq has been riding a roller coaster of volatility.
Market History 101
To help gauge the sustainability of the current bull market, we looked back at more than seven decades of data to see how this latest rally stacks up over time. Dating back to 1950, the previous nine bull runs lasted an average of 5.8 years and none ended before year 3 started.
A Look at Recent Bull Markets
|Trough Date||Peak Date||Change||Length (in Years)||Annualized Return|
|October 1957||December 1961||86%||4.1||16.2%|
|June 1962||February 1966||80%||3.6||17.6%|
|October 1966||November 1968||48%||2.1||20.1%|
|May 1970||January 1973||74%||2.6||23.3%|
|October 1974||November 1980||126%||6.2||14.1%|
|August 1982||August 1987||229%||5.0||26.7%|
|December 1987||March 2000||582%||12.3||16.9%|
|October 2002||October 2007||101%||5.0||15.0%|
|March 2009||February 2020||401%||10.9||15.8%|
Source: Ally Invest, Standard & Poor’s
The S&P 500’s record run since March 2020 has set a tall hurdle to clear. Stocks have a tendency to cool off after the first year of a bull market. In eight of the last nine bull runs, the S&P 500 posted lower returns in the second year than the first.
That said, second year returns have finished positive in every bull market since 1950, with an average gain of 13% (exceeding the long-term average of 8% per year).
Still, financial markets may be overdue for a cooling off period. To date, the S&P 500 has yet to experience a 10% correction since the market bottomed a year ago.
There’s only been one bull market since 1950 when a correction did not occur within the recovery to new highs or the year after reaching new highs, and John F. Kennedy was president when that last happened.
What Lies Ahead
When we combine the anecdotal evidence with the data, we see a scenario where it’s likely that year two of the bull market is an environment where investment performance is driven less by pure price momentum and more by being invested in select areas.
However, the economic tailwinds are just too strong to ignore. Manufacturing activity bottomed last summer and more businesses are re-opening each week. Consumers (many of whom just received another round of stimulus checks) are returning to Main Street with pent-up demand and less debt, which should create an environment where all sectors see profit rebound sharply in 2021.
This type of environment is likely to benefit stocks that lagged over the past year. That means the rally could be led by service-focused stocks over manufactured goods, value stocks over growth and consumer businesses over commercial.
The Bottom Line
Corrections are normal during the course of investing, even in bull markets. History suggests the S&P 500 may not be destined for a sophomore slump, although relatively high valuations could drive investors to be more selective with their investments in 2021. Now may be a great time to reevaluate your investing strategy to make sure your investments still align with your goals.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo-advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.