We are at or near a peak of a second longest bull market in the US history. A bull market is defined by a stock market that keeps on rising without being interrupted by at least a 20% decline.
So how long will this bull market continue? Let's look at what has been driving this bull market and then maybe we can get a better understanding of where it may be going.
It has been a little over eight years ago when the current bull market started after the 2008/2009 recession and it has since grown by nearly 240%, not including dividends.
This means, if you had invested in S&P 500 Index during the depths of 2009 recession, you would have more than doubled your money by now.
After the recession of 2008 and 2009, the Central Bank (Fed) adopted monetary policy to help spur economic growth by increasing liquidity and lowering interest rates. If you remember, during the last recession, banks had stopped lending money, there was simply no more money to lend. We were in a credit freeze environment and the economy was coming to an screeching halt.
Fed's lowering of interest rates and printing money to buy treasury bonds, gave banks the liquidity they needed to start lending again. Businesses and individuals could borrow money at very low cost, which allowed them to start new businesses or grow existing companies and increase profits.
Now in its eight year, the market that has been running on steroids of fed's cheap stimulus money, is just running too fast and getting ahead of itself.
The reason why fed's have been too reluctant to take the foot off the pedal is because the underlying US economy is still not growing at the expected rate and there are fears that by taking stimulus or cheap money off too quickly, we could end up back into recession.
Regardless, Fed's can't keep their foot on the gas pedal forever as it would get harder and harder to bring the economy and market back to its normal growth path.
Feds are now trying to finally slow things down by pulling back on the stimulus. This is being done using two methods. First by slowly increasing interest rates which feds have already started to do, and secondly by unloading of their highly inflated balance sheet of nearly 4.5 trillion dollars in bonds. Some say, it could take up to seven years for feds to fully unwind the balance sheet.
Both interest rate increase and unloading of fed's balance sheet would create a downward pressure on the stock market as there will be higher yielding and less risky options for investors to earn income on their money rather than investing in high risk stock market.
For example, as fed's increase interest rate, a typical savings account will start earning much higher interest rate than what it has been earning in the past eight years of Zero Interest Rate Policy (ZIRP) environment. This will cause the money to flow out of the stock market and into fixed income instruments such as savings accounts, CDs, and bonds. High interest rates can be especially bad for certain dividend paying stocks which have been trading at all time highs and with yields less than 3%.
Therefore, all those investors that have been crowding in the stock market for purely income, will have better and safer options for their money. This by itself will reduce demand for income focused stocks such as dividend paying stocks and overall will create a downward pressure on the stock market.
The other component that has caused some of the recent expansion of the stock market is the Trump effect. As we all have seen what the stock market has done since election, it has been on the tear non-stop for the past seven months.
The Trump effect is purely based on the promises and expectations of easing of corporate taxes, individual tax reforms, better healthcare, and economic policies that puts US companies and individuals at advantage when competing in the US and global economy.
However, expectations must be met with real policy changes or implementations. If none or very few of these promises come true, it will surely to take the air out of the stock market and would just add on to the downward pressure of the fed's stimulus unwind.
Therefore, both slowing down of the stimulus in the form of rising interest rates and deleveraging of fed's balance sheet, as well as deflation of Trump effect would surely to cause the stock market to come back to its senses.
It is time for investors like myself to be very careful when putting any new money in the market at the current valuation. It's even more prudent to buildup cash reserves so that when a market correction happens, you have the money to buy stocks at a very cheap valuations.
It never hurts to take some profits and then wait for the market to correct before reinvesting; however, I would not start selling stocks just because market is at all times high unless I really need the cash.
Remember, more money is made in stock market by buying stocks at a fair to cheap valuations and not when the stock market is running at its all time high. In stock market, patience and discipline is what makes people most money and panic destroys wealth, so stay calm and have a plan for the next correction as it is coming!
Disclaimer: Author of this article is not a licensed/registered financial or investment adviser and does not provide investment advice. Any mention of stock names/tickers in this article or website is not a recommendation to buy or sell. This article is for informational and entertainment purposes only. Full disclaimer can be read here: Full Disclaimer