Business Cycle Recovery Ignites New Bull Market
As much as investors and the media continue to deem the recent strength in global stock prices as a “Trump” rally, we would suggest otherwise. After a mild corporate profit recession in 2015-2016 – which sent global stocks down nearly 20% – corporate profits are now firmly in recovery mode. This corporate profits recovery began in late summer as did the recovery in stock prices and Trump is the lucky beneficiary. Had Clinton won, we are convinced that the media would be calling this the “Clinton” rally! However, investors should be asking themselves “How long will the recovery last? Can stock prices go higher? Is the current administration doomed to wreck the economy and stock market?” Let’s take a look at these questions.
As I wrote in my recently published book The Journey to Wealth, the business cycle, though “tweaked” by politics, has historically never been interrupted or derailed by any one administration. Corporate profit growth, expansions, recessions and the law of supply and demand march to the beat of a different drum than politics. The forces and nature of the business cycle are much too strong for any one administration to manipulate, particularly an administration that faces significant gridlock – which it appears this one may. Therefore investors would be much better off focusing on where corporate profits are likely to expand most and spend less time wringing their hands over what risks the current administration poses to the economy and stock markets. To further emphasize our point consider 1974, when Nixon was impeached: surely one of the darkest and most uncertain periods of political history, yet the beginning of a significant corporate profits recovery and powerful bull market.
We are optimistic that regardless of the administration, the business cycle will continue its recovery not for just days and weeks, but for years. Corporate profit recessions and coinciding bear markets typically take 7-9 years to formulate and this recovery is just at its early stages. As investors we want to ensure that we are significantly invested in the stocks of companies that will likely lead this recovery – which is where understanding the “tweak” of politics can be helpful.
During the early stages of any economic expansion and bull market, the stocks in sectors such as financials, industrials, technology and materials typically outperform all others. You may have noticed that your portfolio has been overweighted in these sectors since prior to the election. Though history does not always repeat itself, in recent months these are the very sectors that have performed best – further confirming that this is likely the beginning of a longer period of recovery. There has been considerable outperformance in financial, industrial and material companies due to the Trump “tweak,” which is fueled by themes such as bank deregulation and infrastructure spending.
This new business cycle recovery should also be welcome to fixed income investors. A stable recovering profit cycle along with steady inflation and unemployment allows the Federal Reserve to easily raise interest rates, which we expect more of this year and next. Higher interest rates allow us to buy bonds with yields that offer value as an alternative to stocks and a way to manage a portfolio’s overall risk.
We are looking forward to a productive year for financial assets, with normal corrections along the way. If, however, our optimism is misplaced or something occurs to derail this view, we stand ready to mitigate the risk of your portfolio through your asset allocation, sector management and the use of carefully placed stop loss orders.
All of us on the team thank you for your vote confidence in our work. If your circumstances have changed or you would like to discuss your portfolio, please let us know. As always, if you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.
Your Team at Main Street Research