We hit the road, hosting our traditional “Back to School” events in the Bay Area. We were in Marin and San Francisco last week and Alamo this week. Our goal was to provide a check-in on where we think we are in this current Bull Market which began in the Spring of 2009, map out where we think we are headed and draw comparisons to its rival, the Dotcom Bull which came to an end in the year 2000.
We entered the year feeling very bullish for the Stock Market. Optimism was not widespread in January. There was a large segment of the population that was concerned if not downright scared about what was ahead. The uncertainty with the new administration and the vast geopolitical issues such as the Russian investigation, a potential trade war with China, and bubbling tensions with North Korea were very real, but unquantifiable. They were overhangs that we thought would continue but not derail the most important factor for the Market; accelerating earnings growth. It’s earnings that drive stock prices. After 2 years of earnings contraction, we believed that a return to growth was ahead and the rally would accelerate in 2017. In our minds, earnings were going to trump geopolitics, and send stock prices higher.
Our work suggests that a breather is now overdue and a 5-10% correction is coming. We’ve prepared for it, but so far it has not materialized. A healthy correction would clear out some of the excesses built up in this rally, and test the uptrend, which we believe has more to go in 2018 before a major top is formed and a deeper decline comes. We project that to be a 2019 event, which would set up another big move higher the 2020’s before this Bull Market finally comes to an end. This is how we see things playing out deep out on the horizon, but will always shift gears if something changes in our work.
So how does this 8.5-year-old Bull compare to the Dotcom Bull from the 1990’s that formed a bubble and burst in 2000? There are some similarities. Both were driven by Technology stocks, which became the largest sector by far. In 2000, Tech accounted for 34% of the S&P 500. Today, Tech is 23%. The Dotcom Bull was up over 400% while the current Bull is approaching 300% gains since inception. The major difference is profitability and valuation. Historically, the S&P 500 has had an average Price/Earnings (P/E) ratio of 15.5X forward earnings estimates. Today it is trading at 17.7X 2018 estimates. That is definitely on the high side, but not ridiculously expensive. When you consider the historic low-interest rates, the current environment is supportive of a higher multiple. Stocks have been much more attractive than Bonds with a comparable income yield. The Dotcom Bull was excessively expensive, trading at over 30X 2001 earnings estimates. And as it turned out, those 2001 estimates were a mirage, and never materialized which resulted in the crash. The Dotcom Bull will be remembered for irrational exuberance and companies like Webvan and Pets.com, which had neither profits nor a plan for profitability.
The current Bull will be remembered for Apple and Google and Amazon and Facebook; the new American Titans in this Digital Revolution in which we live. The seeds were planted in the rubble of the Dotcom bubble burst and the growth accelerated after Steve Jobs launched the first iPhone. That was the game changer, which connected everyone everywhere. Communication, content consumption and commerce all formed a confluence of activity on a very smart mobile device. Innovative companies capitalized on the move disrupting traditional businesses ill-prepared. Amazon certainly took it to the traditional retailers. Start-ups thrived in Silicon Valley and business models were created with an App and a digital footprint. The trends are sustainable and very much investable. The prospects for Artificial Intelligence, Virtual Reality and 3D printing are really just beginning. Many of the stocks are just ahead of themselves right now. The Tech Titans have strong foundations and plenty more growth ahead.
This 2017 rally has exceeded our optimistic outlook. As we approach year-end this Market feels way overbought, but not excessively overvalued. There have been 53 record highs reached in 2017. We got defensive towards Summer’s end and it has proved to be too early. But our conviction that this Market is vulnerable to a correction is still in place. The DOW and S&P have gone up 16 of the last 18 days. The price action has not been normal. And they keep rising in the face of so many concerning issues that are seemingly escalating on a daily basis. At some point, the geopolitical risks will put some pressure on stocks, it just hasn’t happened yet, much to our surprise. On a big picture, we do think there is more room to run for this current Bull. Shorter-term, things look pretty slippery and signals that we are seeing below the surface still indicate a near-term sell-off is way overdue. Investors are pretty excited about DOW 23K. Today’s exuberance is not necessarily irrational, but it has grown in enthusiasm in certain areas. It’s much different than the more somber attitudes in the beginning of the year. Keep in mind, Alan Greenspan gave his “irrational exuberance” speech in 1996, 3.5 years before the bubble burst.
Have a nice weekend. We will be back, dark and early on Monday.