Has the Bull Market Run Its Course?

While stocks have struggled year-to-date, most equity markets are still close to record highs. On a global basis, stocks have gained more than 40% from the summer of 2012 and have advanced 150% from the 2009 lows. Even emerging markets, laggards for most of the past three years, have more than doubled since early 2009.

Today, with many benchmarks exhibiting only nominal gains this year and Japan in negative territory, investors are reasonably asking whether the bull market has run its course, a view reinforced by the fact that there are few absolute bargains left anywhere in the equity market.

Our view: valuations are, for the most part, no longer compelling, but equities are not so stretched as to suggest that valuation alone is likely to end the bull market. Instead, today’s valuations suggest lower returns over the next five years than enjoyed over the previous five, but are not yet indicative of a market top. Of course, either an exogenous shock or a sharp spike in interest rates would change the fundamentals and probably lead to a sharp correction, if not an outright bear market, but neither is our base case scenario.

In fact, there are pockets of relative value—notably Japan, U.S. value and, to a lesser extent, Europe and emerging markets, although stocks are no longer cheap at the aggregate level.

Still, there are a number of areas where investors will want to exercise caution, even though most markets do not look dramatically overvalued. Recent market action has confirmed that many high-flying growth segments—notably biotech and social media—are rich and already reflect unrealistically high expectations. And in terms of a broader market segment that appears overvalued, we would be most concerned about U.S. small caps.