What the Bears Are Getting Wrong About the Bull Rally

As the bull market and the U.S. economic expansion age, the bears are increasingly worried. Taking issue with the pessimists is Tobias Levkovich, chief U.S. equity strategist at Citigroup. “Business cycles don’t die of old age; they are murdered by the Fed or some exogenous shock," he observed in a recent note to clients, as quoted by Barron's. Levkovich refutes four major claims by the bears, as summarized in the table below.

4 Things the Bears Are Wrong About

• "The current expansion is viewed as being ‘long in the tooth’ and thus vulnerable to a recession”
• Rising wages will depress profit margins
• Aside from corporate share repurchases, inflows into stocks are low
• Stock valuations are too high

Source: Tobias Levkovich of Citigroup, as reported by Barron's

Significance for Investors

As noted above, Levkovich takes issue with the belief that the odds of a recession rise as an economic expansion lengthens. Legendary investment manager Bill Miller's recent letter to clients offers his own reasons why the bull market should be far from over. He also refutes the notion that expansions die of old age, citing the fact that Australia is in its 28th year of growth, while also noting several key areas of strength in the U.S. economy that do not appear to be on the verge of reversing.

On the impact of rising wages on profit margins, Levkovich writes: “Wages have not been the cause of margin declines in the past 35 years but fixed overhead cost absorption variances have been. If companies can push any rising employee expenses through to customers (which appears to be happening), the concern about profitability may be overstated.”

Regarding inflows into stocks, he notes that share buybacks have the main driver of demand for equities throughout the current bull market. “We are unsure that so-called retail flows are the driving force anymore as that view seems to be so 1980s and 1990s,” he observes. Per data from EPFR Global cited by the Financial Times, funds that invest in U.S. equities have registered two consecutive weeks of net inflows, the first time this has happened since early Sept. 2018.

“Valuation is regularly cited as a source of anxiety but low inflation allows P/E ratios to hover in the 18x trailing earnings range if history is any guide. Our normalized earnings yield gap analysis still augurs well for S&P 500 gains in the next 12 months with 88% probability," Levkovich asserts. Bill Miller makes a similar observation, arguing that equities are cheap compared to bonds.

While reported earnings for 1Q 2019 so far are beating analysts' estimates, the bears will point to the fact that revenue beats are lagging, as described in detail by MarketWatch. This worries those who see revenues as a more fundamental indicator of corporate health.

Nonetheless, upbeat corporate earnings reports have sent both the S&P 500 and the Nasdaq Composite indexes to new all-time record high closes on April 23, The Wall Street Journal indicates. It says that "expectations may have been lowered too much" ahead of the reporting season, and adds that corporate guidance for the rest of 2019 is trending upwards.

Looking Ahead

The debate between the bulls and the bears is never-ending, and each side marshals facts to support their case. Meanwhile, there is mounting evidence that big investors, the so-called smart money, are cutting their equity exposures, per another story in the Journal. Who is right remains to be seen.