The Stealth Drivers of the Record Bull Market

The Stealth Drivers of the Record Bull Market

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Why has the upswing in the United States stock market lasted for so long?

The simple answer: The economy and corporate profits have been growing for most of the current bull market.

But this rally has had drivers not fully appreciated, perhaps because of a dearth of enthusiasm surrounding its rise. The current bull market occurred in the aftermath of the 2008 financial crisis, a period in which the economy trudged, household incomes only nudged higher, and stock market gains mostly went to the rich.

Still, the Standard & Poor’s 500 stock index is up by 324 percent over nearly nine and a half years. Some things clearly went right. Here are three factors that didn’t get the attention they perhaps deserve.

Wall Street tamed

America’s financial firms often acted as engines of instability during past bull markets. Banks unleashed lending binges that fueled economic growth and increased stock prices. But when borrowers defaulted, banks pulled back sharply, making economic slowdowns and stock market crashes all the more severe. The financial excesses of the five-year bull-run that ended in 2007 illustrate the central role banks can play in creating conditions for a bust.

After 2008, the Federal Reserve and Congress required changes — like safer balance sheets and lending practices — that largely stopped banks from acting in such a destabilizing manner. In the years since the financial crisis, banks have continued to lend to individuals and companies as well as raise money in the markets for their clients. And they have remained profitable. In the first quarter of this year, banks’ profits were equivalent to 1.28 percent of their assets, which is significantly higher than the 1.03 percent median return since the mid-1980s, according to data from the Federal Deposit Insurance Corp.

What could go wrong? The banks are lobbying to loosen many of the post-crisis rules. Gradually, regulators and investors could forget the lessons learned in tough times.

The Fed got it right

Many investors feared that stock prices were being artificially supported by the Fed’s extraordinary post-crisis monetary policies, like its enormous bond-buying programs. There were two main concerns: First, the policies might cause inflation to take off; second, once the Fed withdrew support, it could set off chain reactions that would cause the economy to slow and the stock market to fall. Neither has come to pass, at least so far.

The Fed’s policies may not have been as loose as they appeared. On a nominal basis, interest rates were indeed cut to historical lows. But what mattered is whether they were low after adjusting for inflation. It appears corporate borrowers did not get a huge break from the Fed: During the latest bull market, the yield on corporate bonds rated BAA by Moody’s (a good and historical proxy for average corporate borrowers) was 3.7 percent on average, after adjusting for inflation. That compares with an average of 4 percent since 1950.

What could go wrong? The Fed has so far only tapped the brakes. If it has to tighten monetary policy more aggressively, corporations that have taken on more debt during this bull market may have to pull back significantly. That could set off a bust.

No competition

When the United States became the epicenter of the financial crisis in 2008, it seemed unlikely that it would become a beacon for investors in the next decade. Yet, for the most part, that’s what happened. Europe’s economy took much longer to recover than America’s, mostly because of the region’s sovereign debt crises and a faltering approach to overhauling its banks. In emerging markets, a six-year slowdown that ended in 2017 deterred foreign investors.

Almost by default the United States stock market became the most attractive place to invest. It only became more enticing as large American technology companies kept delivering impressive results. In 2008, United States stocks accounted for 36 percent of the total value of the world’s stock markets, compared with 41 percent in 2017, according to data from the World Bank.

What could go wrong? The world’s desire for United States stocks has pushed their valuations higher and left them vulnerable to shocks, like an all-out trade war or higher-than-expected interest rates. Sam Stovall, the chief investment strategist at the financial research firm CFRA, says a measure of stock market valuations he tracks is at the same level as it was at the time of the 1987 crash.

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