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Preparing For The End Of The Bull Market—Regardless Of When It Comes

The current bull market is the longest on record, and many experts are questioning how much longer the rally can last. For your clients, diversification is more important than ever.

No one can predict the weather more than a few days out, but it's virtually inevitable that a storm will eventually hit. And if you own a home, you don't wait until the storm comes to fix your roof. The same holds true of the stock market. It's impossible to predict how stocks will perform—even one day into the future. Yet it is possible to look at historical trends and see that we're probably closer to the end of the current bull market than the beginning.

For your clients, there's little point in trying to time the market and sell off stocks before any correction might come. Instead, the goal should be to ensure they have the right level of diversification. This includes a range of asset classes, potentially including alternatives, so that they can stay on track for their investing goals regardless of what happens with the market—or when.

Potential Warning Signs

To continue the meteorological metaphor, the past decade—essentially since the market bottomed out in 2009 during the global financial crisis—has been mostly sunshine and cool breezes. During this period, it's been relatively easy to make money with a plain-vanilla portfolio of stocks and bonds—or even stocks alone.

Through the first half of 2018, a lot of major indices had posted 10 year average annual returns of better than 10 percent, including the S&P 500, the Russell 2000, the Russell 3000, and the MSCI US Broad Market Index.1 For investors, that's like throwing darts and only hitting bulls-eyes.

Yet there are some warning signs that this long rally may be in overtime. Consider:

  • The current bull market is now the longest of the modern era. It is longer than the 1990s rally, which ran for 114 months and ended with the tech crash.2 Throughout the past century, stocks have been cyclical—no rally lasts forever.

  • Stock valuations are at the high end of their historical averages. Prices for the S&P 500 overall are now about 23 times trailing earnings, a level they have only hit once in the past two decades. (That was immediately after the financial crisis, when earnings were far lower.)3

  • The "yield curve" on bonds is flattening. This curve shows the relationship between rates on short-term and long-term bonds. Under normal circumstances, long-term bonds typically pay higher-interest rates, which makes sense. But currently, rates are close for the two categories, and if the Fed continues to increase rates—as expected—the yield curve could be flat by the end of the 2018. In the past, inverted yield curves have signaled that a recession could be coming.4

To be clear, bulls would argue that consumer confidence is still high, unemployment is low, and economic growth seems sustainable. But the preponderance of numbers like this have some experts saying the easy gains could be behind us.5

The Case for Diversification

Given these indications, is there an argument for getting entirely out of the stock market? Definitely not. Trying to time the market is impossible, and bull markets often generate significant gains in their final months.6

However, it's possible to take some steps that could help to stormproof a portfolio. Specifically, diversifying away from a straight stock-and-bond strategy and mixing in some asset classes that have a low correlation to equities can potentially reduce the volatility of a stock correction.

Alternative investments such as real estate and private capital have different returns and risk profiles than stocks and bonds. And because they are not publicly traded, they have a lower correlation to those investments. This kind of diversification can reduce some of the volatility risk from a concentrated portfolio. It may provide a cushion when stock prices fall, and some alternatives may continue to generate income in a declining market.

In sum, the right asset allocation, with a healthy amount of diversification into alternatives and other assets that don't correlate with stocks, could help your clients build a portfolio that will help them reach their goals regardless of when the current bull market ends—or when the next one begins.

1 "Benchmark Returns," Vanguard, data as of July 22, 2018.
2 "Visualizing the Longest Bull Markets of the Modern Era," Visual Capitalist, June 14, 2018.
3 Kailey Leinz, "End of a Bull Market, or Nowhere Near? Making the Case for Both," Bloomberg, February 7, 2018.
4 Ben Levisohn, "Why the Bull Market Could End in 2020," Barrons, June 30, 2018.
5 Jeff Cox, "Morgan Stanley Issues Warning that the End is Near for the Bull Market," CNBC.com, April 17, 2018.
6 Mark Hulbert, "How to Prepare for the End of the Bull Market," USA Today, January 14, 2018.

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