The beloved children's story written by Munro Leaf, The Story of Ferdinand, introduces readers to a bull that is not quite what he seems. Outwardly, Ferdinand is 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 without a draw down greater than 20% is undoubtedly impressive. But, like 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 does not rank in the top five. Its length is not necessarily matched by its strength.
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.
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.
It is 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 is important to consider the nature of the current bull, not just its size. Since excessive valuations can be an arbiter of market pullbacks, one must consider the market today relative to past 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.
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 do not forget about the other asset classes in your portfolio that the headlines may have overlooked, their day in the ring may be coming.
Do you have questions about this article or your portfolio? Contact any of the advisors at Fi3 for more information.
Disclosure: While this article addresses generally held investment philosophies of Fi3 Advisors, it does not represent a specific investment recommendation for any individual client or prospective client. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Information has been obtained from a variety of sources believed to be reliable but not independently verified. Past performance does not indicate future performance.
 Reference to the current bull market calculate data from 3/9/2009 – 8/22/2018.
 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.