Weekly Economic Commentary | Week of March 3, 2014

posted 3/6/2014 in Investments

Highlights

After five years, the second most powerful bull market in post-WWII history may be getting a second wind.

Stocks Go From Great to Good as the Bull Turns Five

The end of this week will make it five years since the second most powerful bull market in post-WWII history began [Figure 1]. After five years, only the bull market that began on August 12, 1982 was stronger. It is not over yet. In fact, the bull market may be getting a second wind.
 


Stock Market Investors Chase Five-Year Returns

Despite its strength, the bull market has only recently been discovered by individual investors.
Investors tend to chase returns. For the U.S. stock market, investors have most closely followed the rolling five-year annualized return, based upon their investing behavior [Figure 2]. The five-year trailing annualized return for the S&P 500 Index had been weak, especially when compared with bonds, in recent years. But in 2013, the five-year return began to see a dramatic change.

Even as recently as the end of August 2013, the difference in the five-year annualized return between stocks and bonds was only about 2%, hardly enough to compensate investors for the volatility they experienced. By November 2013, the five-year return soared into the double digits -- reflecting not only a strong recent gain in the stock market, but the dropping off of much of the horrific declines in the fall of 2008, when the financial crisis took hold. This week as we approach the March 9, 2014 five-year anniversary from the bear market low in the S&P 500 -- assuming no change in the S&P 500 between now and then -- the five-year annualized return will have exceeded bonds by 20% [Figure 3].


With the five-year trailing annualized returns for stocks in the double digits for the first time this
cycle, investors are beginning to pour money into funds that invest in U.S. stocks after years of selling,according to data from the Investment Company Institute (ICI). It is no surprise that this took place just as the five-year trailing return for stocks began to soar into double digits. In fact, even during this year's January stock market pullback that peaked out at about a 6% decline, U.S. stock funds saw inflows during three of January's four weeks. This may be because the five-year return investors tend to focus on actually rose despite the decline in the stock market in January (since the even steeper decline in January 2009 rolled off the five-year period).


Corporate share buybacks have accounted for much of the stock buying in recent years, and
corporations will likely remain buyers in 2014. However, individual investors as a group may finally
be starting to buy stocks again in contrast to much of the past five years. This may help to continue a rise in valuations and sustain the bull market.


The Next 10 Years

The last five years have been outstanding, but what do the next five or 10 years look like for the stock market? Many investors who avoided stocks during much of the past five years did so because they thought stocks may not ever again produce gains like they did in the 20th century.

Historically, the valuation of the stock market, measured by the trailing price-to-earnings ratio, has been a very good indicator of long-term returns. Currently, the S&P 500 valuation suggests that over the next 10 years, stocks may produce mid- to high- single-digit gains, as you can see in Figure 4. This does not includedividends, which may add another 2%, based on current yields.

Even though this is likely to come with volatility including a possible recession and bear market along the way, this performance would be substantially better than the next 10 years of low single-digit gains of 2-3% suggested by current values for bonds in Figure 5.
 


While the relationships highlighted over the past 25 years in Figures 4 and 5 are compelling, the
longer-term look back in Figures 6 and 7 show that the predictive relationship of valuation and
performance has worked consistently in the many different economic, political, and demographic
environments of the 20th century -- and into the 21st as well. The Barclays Aggregate Bond Index
does not go all the way back to the early or middle part of the 20th century, so instead we have used intermediate-term government bonds as a proxy for all high-quality bonds.New investors in the stock market and those that have participated for many years can take heart.


While a great five years of stock market performance is now behind us, we have the potential for a good 10 years to look forward to based on predictive relationships that have withstood the test of time.
 
 
IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to
provide specific advice or recommendations for any individual. To determine which investment(s)
may be appropriate for you, consult your financial advisor prior to investing. All performance
reference is historical and is no guarantee of future results. All indices are unmanaged and cannot
be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges.
Index performance is not indicative of the performance of any investment. Past performance is no
guarantee of future results.


The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.


Stock and mutual fund investing involves risk including loss of principal.


The Investment Company Institute (ICI) is the national association of U.S. investment companies,
including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts
(UITs). Members of ICI manage total assets of $11.18 trillion and serve nearly 90 million
shareholders.


The P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the
annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.


Trailing P/E is the sum of a company's price-to-earnings, calculated by taking the current stock
price and dividing it by the trailing earnings per share for the past 12 months. This measure differs
from forward P/E, which uses earnings estimates for the next four quarters.


Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of
common stock. EPS serves as an indicator of a company's profitability. Earnings per share is
generally considered to be the single most important variable in determining a share's price. It is
also a major component used to calculate the price-to-earnings valuation ratio.


INDEX DESCRIPTIONS

The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks designed to
measure performance of the broad domestic economy through changes in the aggregate market
value of 500 stocks representing all major industries.


The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, anddollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and
asset-backed securities.


The Barclays Government/Credit Intermediate Index is a market value weighted performance
benchmark for government and corporate fixed-rate debt issues with maturities between one and 10 years.


All indices are unmanaged and cannot be invested into directly. The returns do not reflect fees, sales charges or expenses. The results don't reflect any particular investment.


This research material has been prepared by LPL Financial.


To the extent you are receiving investment advice from a separately registered independent
investment advisor, please note that LPL Financial is not an affiliate of and makes no
representation with respect to such entity.


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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
 
The financial consultants of Wealth Management are registered representatives with and Securities are offered through LPL Financial. Member FINRA/SIPC. Insurance products offered through LPL Financial or its licensed affiliates.
 
                                  Not FDIC/NCUA Insured Not Bank/Credit Union
                                               Guaranteed May Lose Value
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