Why the US bull market still has further to run - Investment Comment

Volatility is likely, but the fundamentals favour the bulls

Recent economic data from the US clearly indicates that the world’s largest economy is now much closer to reaching self-sustaining growth. The Institute for Supply Management’s (ISM) Manufacturing Index continues to show expansion, with its latest reading at 53.5 (albeit down fractionally from the previous month). The services-oriented ISM Non-Manufacturing Index – representing a much larger share of the US economy – rose to 56.7 in January, while orders strengthened to 59.5.

The jobs market is underpinning the US’s momentum, with initial jobless claims battling volatility yet remaining consistently below the key 300,000 level. Crucially, the economy continues to create jobs, with another 257,000 added in January, while the previous two months were revised higher by 87,000 jobs collectively. The unemployment rate did tick up to 5.7 per cent, reflecting more people entering the workforce as the labour participation rate rose. But the strength in the labour market may be starting to be reflected in a modest increase in wages, as the Employment Cost Index (ECI) showed a 2.3 per cent year-over-year gain in the fourth quarter of 2014. In addition, average hourly earnings rebounded from December by posting a 0.5 per cent gain in January.


While the economy has continued to improve, the US stock market has been particularly volatile lately, with 18 out of the 20 trading days in January having witnessed greater than 1 per cent moves in the S&P 500. Though February seems to have calmed somewhat, we believe that 2015 will be marked by sharp pullbacks, and while we think the secular bull market remains intact, we do see the possibility of a decent-sized correction in the US for the first time in several years.
Valuation expansion has likely gone as far as possible in this environment, leaving earnings to do more of the heavy lifting. As a result of these pressures on earnings, the market may have a tougher time generating the kind of returns which investors have recently enjoyed.
Along with the uncertainty regarding global growth and US Fed policy, the potential spark for a sell-off could come from a crisis associated with the fall in the price of oil, even more sudden moves in the US dollar and, of course, ever present geopolitical concerns. Also notable is the period of time we have been without a market correction; currently three and a half years. Historically, US markets typically undertake a correction every 18 months or so.


That said, the third year of an election cycle has historically been kind to the US stock market. Going back to 1928, the market return of the third presidential year averages at a remarkable 13 per cent, with the year ending in positive territory 86 per cent of the time. The recent strength of the dollar also has an interesting historical pattern. When the Dollar Index (which monitors the relative strength of the dollar against a basket of international currencies) has risen by more than 10 per cent – as it did in 2014 – the following year has seen an average return of nearly 15 per cent, with no negative years. This pattern goes all the way back to 1965. Of course history doesn’t always repeat itself, as Mark Twain famously noted, but it can occasionally rhyme.


So although we may experience high degrees of volatility in the short term, the underpinning of a strong economy driven by job creation and a resurgent consumer will likely see a continuation of the US bull market. On a comparative and absolute basis, the US continues to be head and shoulders above its developed market peers and, while the stock market could no longer be classed as great value, in bull markets valuations can continue to be stretched.
US investments should be an important consideration for any stock investor, due to the sheer size of both the economy and the market. More often than not, however, a home bias tends to lead to underexposure to the world’s largest and most liquid stock market. Nearly every home in the UK will purchase US-generated products and services, but only a small percentage of households invest in the opportunities that the US market can offer.
While there may be some short and medium-term volatility, a strong economy means the outlook for the US is positive in the longer term. Though there may be more gains to be had in other, more speculative markets, these are more suitable for those investors who feel they have sufficient US exposure or for those who may be willing to take on a little more risk in their portfolios.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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