Is Ferdinand the Bull the Face of Today’s Market?

Have you read the popular children’s story written by Munro Leaf, The Story of Ferdinand, about a bull that is not quite what he seems? The story’s theme could also apply to today’s bull market.

Ferdinand appears to be every bit the fierce, imposing figure that the local matadors covet. Yet while the fellow bulls in his pasture are constantly roughhousing and butting heads in the hopes of being selected to fight in the ring, Ferdinand prefers the quiet solitude of sitting under a cork tree, sniffing flowers. Even when a twist of fate lands Ferdinand in the ring, he still does not fight, choosing instead to sit in the middle of the ring and sniff the flowers that adorn the hair of the women in the arena.

Recently, the bull market that first entered the ring on March 9, 2009, became the longest on record. Predictably, national media outlets made this front-page news. While there is some disagreement as to how to actually measure a bull market’s length, the 320% rise in the S&P 500 over 3,453 days [1] without a draw down greater than 20% is undoubtedly impressive. But, like our dear Ferdinand, is this bull really what it seems?

To begin, let’s distinguish between length and strength, the latter of which is arguably more important to investors. The 320% gain in the S&P 500 during the current bull market represents an average monthly gain of approximately 2.8%. While notable, when compared to past, shorter bull markets, its monthly return doesn’t rank in the top five. Its length isn’t necessarily matched by its strength.

CWO Chart on Avg. Monthly Total Return of S&P 500
Further, one could reasonably question the relevancy of the bull itself. In this case, the bull is the S&P 500, the broadly accepted index composed of large cap U.S. stocks. For many institutional investors, this represents a single allocation within a broadly diversified portfolio. The Uniform Prudent Management of Institutional Funds Act, or UPMIFA, advises that “an institution shall diversify [its] investments” unless there is a defensible reason not to do so. As such, institutional investors include not only U.S. stocks, but foreign stocks, global bonds, real assets and alternative investments in their portfolios. Importantly, data suggests that for many institutional investors, the allocation to U.S. equities represents a minority of their portfolio investments.

CWO chart on average allocation to US equities

Thus, while the bull market in U.S. equities has been beneficial and relevant to many, institutional investor total returns are highly dependent on the performance of a myriad of asset classes. With the exception of REITs, no other broad asset class examined below comes close to the bull market gains of U.S. stocks. And, rather than charging ahead, certain asset classes (hedge funds, commodities and bonds) simply sat down to smell the flowers, producing returns well below their long-term historical averages.

CWO chart on annualized total returns

It’s common that any talk of the length of a bull market is often infused with the sentiment of impending doom. After all, every bull eventually succumbs to the matador, right? Perhaps, but as with Ferdinand, it’s important to consider the nature of the current bull, not just its size. Since excessive valuations can be an arbiter of market pullbacks, it’s important to consider the market today relative to history.

The current Shiller CAPE (Cyclically Adjusted Price/Earnings) ratio on the S&P 500 is approximately 33.0x. At least by historical standards, this valuation is high. When looking at the largest 100 monthly CAPE values on the S&P 500 since 1872, today’s valuation falls in the middle of that group. However, this may understate things; many of the periods that included higher valuations were during the internet bubble of the late 1990s. While we may not be at those lofty CAPE ratios that preceded the collapse of the “tech bubble,” valuations do sit near historical highs.

CWO Chart Shiller Cape

So, what does all this mean to the diversified long-term investor? Hopefully, not much. Headlines can be tempting, and the constant news of this bull’s historic run can force even the most disciplined of investors into errors in judgement. “Should I sell all my stocks now?” (The graveyards of Wall Street have no shortage of “market timers”). “Should I have just invested in U.S. stocks? Why do I need to invest in (insert asset class here) anyway?”

Our advice remains steadfast:
• Remember that diversification is a prudent fiduciary principle. (UPMIFA validates this.)
• Build your portfolio around your own Three Levers: inflows, outflows and required rate of return, not the current whims of the market.
• The risk you take should be a function of your required return — no more, no less.

Long-term investors have the luxury of tuning out short-term market noise — why deprive yourself of this luxury? Instead, take a matador’s bow, as the current bull market has undoubtedly lifted the U.S. equity returns within your portfolio. But don’t forget about the other asset classes in your portfolio that the headlines may have overlooked; their day in the ring may be coming.

Contact an advisor at C.W. O’Conner Wealth Advisors, Inc. for more information.

All material and information is intended for C.W. O’Conner Wealth Advisors, Inc. business only. Information is obtained from a variety of sources which are believed, though not guaranteed, to be accurate. This article does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. C.W. O’Conner Wealth Advisors, Inc. and its employees do not provide legal advice, and do not provide tax advice outside of the advice given in relation to financial planning and asset management services.

[1] Reference to the current bull market calculate data from 3/9/2009 – 8/22/2018
[2] Indices used = Bonds; BBgBarc U.S. Agg Bond TR USDm Inception 1/1/1976; Commodities: Bloomberg Commodity TR USD, Inception 12/31/1990; REITs: FTSE NAREIT All Equity REITs TR USD, Inception 12/31/1971; Developed International: MSCI EAFE NR USD, Inception 3/31/1986; Emerging Markets: MSCI EM NR USD, Inception 12/29/2000; Large Cap U.S.: S&P 500 TR USD, Inception 3/31/1936; Hedge Funds: HFRI Fund Weighted Composite. Bull market return 2/28/09-7/31/18. Inception 1/90-7/18.