As of last week, the current global bull market and corresponding economic expansion is officially in its seventh year, which by historical standards is becoming elderly. It is true that history doesn’t always repeat itself. However, in terms of the business cycle, economic recessions – and corresponding bear markets – have appeared every 7-9 years with regular frequency over the past half century. Should we sell all of our great stocks and run for the hills? No! Should we become increasingly focused on risk management? Yes! Interestingly, the last year or two of a bull market often offers some of the best upside performance and our research suggests that this may be in store for us this year and potentially next.

There are signs that the great economic and stock market recovery that began in the spring of 2009 has aged. Pick any number of economic statistics – industrial production, auto, retail, or high end real estate and art sales – and you get a clear picture that we are no longer in the early stages of this expansion. In addition, as stock markets age, the number of sectors and stocks that continue upward usually begins to narrow. Of the ten global economic sectors, only eight continue to move higher. Material and Energy stocks have fallen into bear markets – stocks we sold prior to their most significant declines. Stock prices relative to history are no longer a bargain at current levels – but that doesn’t mean they can’t keep going up, perhaps significantly, for a while longer.

In the face of its age, the global economy has recently shown signs of strength, particularly in high quality European economies – where we have recently been making investments. Perhaps a seven year old expansion and bull market is the new four? But we doubt it. Often during the late stages of an expansion, economic and profit growth accelerates. This growth is often the “wakeup call” to those investors who may have missed most of the bull market. Believe it or not, there are a bunch of them still! It is this final demand for stocks by the “latecomers” that have historically pushed prices significantly higher – a period we do not want you to miss.

The question investors should be asking is how and when will this great recovery end? We would suggest that, like many, many times before, the Federal Reserve will bring the expansion to an end by raising interest rates too quickly. On that basis, we would suggest that the bull lives for at least another year. The good news for all of us investors is that higher interest rates bring a more attractive bond market. This will be a great place to reside while stock prices readjust to recession levels.

In an effort to manage the risk of your portfolio during these late stages, we will be reducing your overall stock exposure at a measured pace. We will also manage your portfolio’s risk by changing your economic sector exposure. Lastly, we will continue to apply stop loss orders to each stock that we feel would be vulnerable in an economic decline. All of these risk management tools are applied to mitigate the risk of catastrophic loss – which worked well for us in the market decline of 2008.

All of us here appreciate the confidence you have placed in our team. If you have experienced any change in your financial circumstances or would like to discuss your portfolio please let us know.

Sincerely,

Your Team at Main Street Research