Editor's Note: This blog has been updated to include more recent data. It was originally published in August 2017.
The Ship of Theseus—also known as The Theseus Paradox—is an ancient parable about a king who sails from one side of the ocean to the other. Each time a plank on his boat decays, he replaces it with a new one. By the time he gets to the other shore, every wooden part of the ship has been replaced. One must wonder: is he sailing in the same boat or a new one?
The same question could be asked about today’s bull market, which has earned the distinguished title of the longest running bull market ever.1 With this new milestone, I must ask, have we endured multiple cycles and are we in a “new boat?” Or are we still riding in the same “old boat” that launched in 2009?
The bull market’s multiple fits and starts
A bull market is defined as a collection of securities that are rising, or expected to rise. Its end—a bear market—is marked by a decline of more than 20% over at least a two-month period. Today’s bull market, captured below, began March 9, 2009.
Because this bull market run has experienced numerous fits and starts, it begs the question of which vessel we are now sailing in. Often, these fits and starts have been drastic, leaving the impression that the entire starboard side of the boat has been replaced rather than one plank. The following charts capture seven such market-rattling events:
1. The Debt Ceiling Downgrade of 2011: The S&P 500® Index fell 19.3% peak to trough after Standard & Poor’s downgraded the US credit rating for the first time.2
2. The Taper Tantrum of 2013: Interest rates rose while global and US stocks fell by nearly 9% and 6%, respectively, after the Federal Reserve (Fed) discussed a reduction in quantitative easing.
3. The Fall of Energy in 2014: Oil prices were swept out to sea and stocks were caught in the riptide, dropping precipitously in the fourth quarter of 2014.
4. The Surprise Devaluation of the Renminbi (CNY) in 2015: Equity markets plunged after China, the world’s second-largest economy, unexpectedly devalued its currency.
5. A String of Negative Earnings Growth from 2015 into 2016: S&P 500 corporations reported seven consecutive quarters of negative year-over-year earnings growth, and stocks, after ending 2015 with a negative return, were poised for similar single-digit returns in 2016 until the post-election rally.
6. The “Trump Bump” of late 2016 into 2017: After the presidential election win of pro-business and anti-regulation candidate Donald Trump, stocks sparkled with just a slight fade here and there—perhaps indicating a new bullish plank had been placed in the bull market ship.
7. The “Inflation Irritation” of early 2018: After inflation surprised to the upside on the heels of a new fiscal stimulus package passed by the Trump administration, yields and breakeven inflation rates rose in early 2018. At the same time, US equities surged by more than 5% in January, stretching valuations. Equity markets re-rated and entered a technical correction, falling by more than 10%. With this new plank, the bull had to acknowledge the reality that the Fed would stay its course with projected rate hikes in the face of rising inflation—especially after central bankers stated at their January 31 meeting that the economy was expected to strengthen in a way that would “warrant further gradual increases” in interest rates.3
With this “Inflation Irritation,” it begged the question: had that bullish Trump Bump plank in the boat been replaced by the plank of higher rates? Equity markets recovered off the back of strong earnings; however, the anomalous levels of low volatility from 2017 have now been clearly replaced by normal crosscurrents of volatility.
Is today’s bull market a modern-day Ship of Theseus?
Investors may be of two minds:
- Some may think no, this is a monolithic market, we are not in a new regime, and a market correction of 20% could be just around the corner. While bull markets don’t die of old age, they do die of something, and investors may believe today’s bull run may be standing at a peak.
- Other investors may think yes, we are in a new ship with the wind in its sails to propel it forward. After all, earnings growth in the US is robust, US unemployment is historically low, and global growth, while waning, is still positive. Policy planks have been replaced as well, as the Fed has moved on from its zero interest rate policy, and other central banks, like the Bank of England, are either beginning to implement monetary tightening or, in the case of the European Central Bank, using forward guidance to forewarn investors of the removal of post-crisis reforms.
New ship or old, be sure to adjust portfolios
Based on your view of the bull market, make sure to tweak portfolios accordingly:
- Old boat: If you believe the end is nigh, you may want to consider risk mitigation, ensuring portfolios are structured with a diversified foundation, complemented by exposures with uncorrelated return streams to traditional stocks and bonds. With higher rates on the short end, ultra-short duration vehicles may be one vessel that is able to provide equity downside risk mitigation with minimal duration risk while offering the potential for income generation. This is underscored by the fact that the yield on the US 3-Month Treasury Bill is higher than that of S&P 500 equities.4
- New boat: If you believe there are more tactical opportunities, you may want to seek them in sectors where there’s strong earnings growth, attractive valuations and supportive economic trends—like US financials, health care, and tech stocks.
As for my view, I believe the bull market that started in 2009 has ended—the ship that set sail when “Boom Boom Pow” by the Black Eyed Peas was the number one song on the Billboard charts has changed materially. The regimes have shifted and the chess pieces have moved all over the chessboard, but this doesn’t mean we entered a bear market at any time during this period. Rather, the ship in which the market has sailed into 2018 has had many planks replaced.
For investors, this means that there continue to be opportunities to harness. However, just as easily as a plank of opportunity can arise, it can decay just as quickly. Lately, protectionist policies from the Trump administration have led investors to question whether or not the robust economic growth we witnessed this past quarter is peaking, and the path ahead may feature a groundswell of volatility. So far, emerging and developed market ex-US equities have been caught in this undertow, falling by nearly 4% in 2018.5
Nonetheless, portfolio construction is paramount, and given the current tenuous geopolitical situation, investors should be prepared for risk-off/risk-on markets with portions of a portfolio carved out for tactical return opportunities and risk mitigation strategies.
1"The longest bull market of all time?", finance.yahoo.com, as of 8/6/2018
2S&P downgrades U.S. credit rating for first time, washingtonpost.com, as of 8/2/2011
3Federal Reserve, as of 1/31/2018
4Bloomberg Finance L.P., as of 8/8/2018
5Bloomberg Finance L.P., as of 8/8/2018, based on the MSCI ACWI-Ex US Index
Bloomberg West Texas Intermediate (WTI) Cushing Crude Oil Spot Price
Bloomberg's spot crude oil price indications use benchmark WTI crude at Cushing, OK; and other U.S. crude oil grades trade on a price spread differential to WTI, Cushing. Prices are on a free-on-board basis. West Texas Intermediate crude oil at Cushing, OK typically trades in pipeline lots of 1,000 to 5,000 barrels a day for delivery between the 25th of one month to the 25th of the next month. These prices are for physical shipments.
CBOE VIX Index
The VIX Index is short for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options.
A slang term referring to marketable securities that are highly liquid and considered cash-like. Dry powder may also refer to cash reserves kept on hand to cover future obligations or purchase assets, if conditions are favorable.
MSCI ACWI Index
A free-float weighted global equity index that includes companies in 23 emerging market countries and 23 developed market countries and is designed to be a proxy for most of the investable equities universe around the world.
Quantitative Easing (QE)
An extraordinary monetary policy measure in which a central bank buys government fixed-income securities to lower interest rates, encourage borrowing and stimulate economic activity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Russell 2000 Index
A benchmark that measures the performance of the small-cap segment of the U.S. equity universe.
S&P 500 Index
The S&P 500, or the Standard & Poor’s 500, is an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices.
The bond market selloff that began in the spring of 2013 after former Federal Reserve Chairman Ben Bernanke said the Fed would begin to “taper” its “quantitative easing” bond buying program. The selloff caused bond prices to fall and bond yields to rise for most of 2013. But yields began to fall in late 2013 and 2014 amid continued signs of economic weakness.