The next bull market in terms is unlikely to resemble the previous one
Will the next bull market in stocks resemble the previous one? Don’t count on that.
As major North American benchmark indexes rise above recent lows in October, Thursday’s strong rally is based on the data. US inflation easing in October – It’s natural to wonder if the worst of this year’s merchandise is behind us.
There are still many threats hanging in the market, of course. inflation remains a threat, central banks will likely continue to hike interest ratesit exists in a form recession and corporate profits are slowing.
However, observers are now wondering what issues might drive the next sustained rally and what leaders might emerge.
There’s a big payoff for anyone who gets it right. Stocks that tap into broad secular trends can generate surprising long-term gains, in some cases not only leading the stock market for years, but defining it.
Think of tech stocks in the 1990s, the commodity boom before the 2008-09 financial crisis, or even the work-from-home-and-shop issue that drove many tech stocks to dizzying heights during the worst months of the COVID-19 pandemic.
While it’s impossible to know which way the major indexes will go, there’s one thing many market watchers agree on: new bull markets create new leaders.
“What we tend to find is that after significant bear markets, the subsequent bull market is led by a different group of stocks,” said Ben Inker, head of asset allocation at GMO LLC, a Boston-based global asset manager.
This is not a coincidence, but a reflection of market psychology and economics; powerful factors that could hinder a sustained rebound faltering superstars, such as Facebook parent Meta Platforms Inc., Shopify Inc., Amazon.com Inc. and Google parent Alphabet Inc.
“Even though the market doesn’t tend to learn its lessons for very long, people still have at least brief memories of the pain,” Mr. Inker said. “And the things that have been hurting lately are rarely the ones that lead to the next phase.”
In a report released this summer, New York-based Richard Bernstein Advisors added another reason why bear markets — defined as declines of 20 percent or more from their peaks — can lead to change: Stocks that lead bull markets tend to adjust to the economy. of the time but as the economy changes, market leadership changes along with it.
This view may be against this week’s rally. A report showed year-on-year US inflation fell to 7.7 percent last month from 8.2 percent in September, with earlier stock market winners leading the rebound.
The tech-heavy Nasdaq Composite Index rose 7.4 percent on Thursday, rewarding investors who bet on a recovery from the previous bull market.
But recent history suggests the rebound may fail.
An example of leadership change is the tech bubble of the late 1990s. Information technology stocks rose 360 percent in the three years from March 1997 to a peak in March 2000. After the dot-com bubble burst, however, tech stocks were the worst-performing sector for the next three years.
Energy stocks took a leading position after the technology stock market started to recover from the crisis. The sector led the S&P 500 Index for the three years from October 2004 to October 2007 as crude oil prices rose. among the forecasts it would rise to $200 per barrel.
But the financial crisis of 2008-09 caused oil prices to deteriorate. Canada’s energy sector fell 29 percent over the next three years as investors sought financially defensive stocks.
During the last two years of the bull market, from 2020 to early 2022, low interest rates lifted the value of what are known as long-dated assets: companies with promising growth but earnings that may take years to show consistently.
Consider Peloton Interactive Inc., which makes Internet-connected bikes and treadmills. Its share price rose 400 percent in 2020, despite annual losses during this period. Or look at Shopify, the e-commerce software giant that topped the list of Canada’s most valuable companies from May 2020 until the bull market fizzled this year as interest rates began to rise.
“The reality is that rates were too low for too long, and they are returning to the normalized levels of 3 to 4 percent. That idea of free money is going to go away,” said Brian Belski, chief investment strategist at BMO Capital Markets.
Therefore, long-lived assets with high valuations, Mr. Belski added, “will not be part of the leadership any time soon.”
What will lead to the next bull market?
As many observers expect expensive stocks that promise distant gains to struggle, cheap stocks that are currently generating significant returns — perhaps with slower growth potential — have many strategists looking for opportunities.
In a very general sense, this approach boils down to cheap value stocks, such as slow-growing mature companies, and is outperformed by more expensive growth stocks, such as nimble technology companies. It may already be working, given the divergence of exchange-traded funds that focus on one approach or the other.
Vanguard Growth ETF, Alphabet, Meta, Tesla Inc. and the fund, which holds other high-tech stocks, is down 30 percent this year.
But the Vanguard Value ETF, Berkshire Hathaway Inc., Johnson & Johnson and JPMorgan Chase & Co. which has tougher stocks like , despite the decline, has outperformed the growth fund by 26 percentage points.
Value-oriented investors such as GMO’s Mr. Inkers expect the decline in growth stocks to continue.
“If this bear market does what it’s supposed to do, the stories that lead to the next bull market won’t be based on the illusion that you’re going to get rich,” he said. Instead, they will be “in boring companies, trading at sharp valuations.”
Dividends can also play an important role.
David Kostin, chief US equity strategist at Goldman Sachs, argued in a research note in late October that companies that return cash to shareholders typically outperform when economic growth slows, which is the economic scenario he expects in 2023. High dividend growth stocks are trending. to work even better, he said.
Other observers are focusing on issues that will dominate as the North American economy reverses years of offshoring and companies develop larger domestic operations to avoid supply chain problems that weighed on shipments during the pandemic.
“We believe assets from around the world are coming back to North America,” Mr. Belski said. This should encourage money from small businesses and large industries and finance, he added.
It’s also bullish on long-term energy, a call that has fueled much market debate in recent months, to the point where the sector looks like the best chance to lead the bull market.
A key reason: Producers are emphasizing dividends, share buybacks and debt repayments rather than expanding output, winning praise from institutional investors for their discipline and ensuring oil and gas shortages maintain a value.
“They are taking excess cash flow and increasing buybacks or growing dividends, which is constructive for shareholders and drives the supply-demand cycle over the medium term,” said Simon Skinner, head of the European investment group at multinational Orbis Investment Management. . .
The energy sector has already generated impressive returns in 2022 S&P/TSX Canada’s energy sector shares are up 65% this year on rising oil and natural gas prices. The S&P 500 Energy sector of US issuance is up 69%.
However, the rally may not be getting old. North American energy stocks have returned to levels of a decade ago, and the weighting of energy stocks within global benchmarks is still a fraction of what it was before the financial crisis.
“Even entering the recession, energy prices seem to hold with a higher weight. And even if oil prices fall, energy companies are generating tremendous free cash flow,” said Kurt Reiman, senior North American strategist at BlackRock Inc., the financial giant with $8 trillion in assets under management.
Of course, investors may be tempted by stocks that led the last bull market and are now trading at deep discounts from recent highs, especially after Thursday’s rebound in tech stocks.
But if history is any guide, and if the economy changes to accommodate higher interest rates and inflation, the old bets may fail. New market leaders (perhaps energy producers, value stocks, dividend payers, or combinations of the three) can reward investors for years.
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