Investing Late in a Bull Market

Essential Strategies for Today’s Investor

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A bull market for the record books

This is currently the second-longest S&P 500® Index bull market on record, with the third-highest price return (295%). Scroll down to see how it compares to previous bull markets.

In this report, we identify signals that might indicate whether the bull market is nearing its end and offer strategies for the latter stages of a bull market.

NOTE: A larger circle represents a bull market with a higher return.

Sources: Bloomberg, FactSet, and Wells Fargo Investment Institute, March 31, 2018. For illustrative purposes only.

The market is represented by the S&P 500 Index. Index returns reflect general market results and do not reflect actual portfolio returns or the experience of any investor, nor do they reflect the impact of any fees, expenses, or taxes applicable to an actual investment. The S&P 500 Index is a market-capitalization-weighted index that is generally considered representative of the U.S. stock market. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Average vs. Current Bull Market Length Average vs. Current Bull Market Return

Capitalizing on the long-running bull market

This video highlights what investors should know as we enter
the bull market’s later stages.

View transcript

Four Late-Cycle Signs to Monitor

Signals that point to potential risk in the economy and markets can include widening credit spreads, investor complacency, rising interest rates, and potential asset bubbles.

Although we have seen signs of investor complacency in 2017 and early 2018, other factors are not foretelling that a recession is likely in the near term, supporting our view that the bull market still has some room to run.

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1. Widening credit spreads

Credit spreads measure the amount of increased return an investor requires for a given company’s credit risk. As the economy enters the latter stages of the cycle, business risk increases. Investors then demand more return, resulting in wider (higher) credit spreads.

What we’re seeing

There currently are few signs that credit spreads are widening.

As shown here, neither high-yield nor investment-grade credit spreads on taxable bonds have shown signs that investors are asking for higher returns to compensate for increased risk.

 

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U.S. credit spreads have yet to significantly widen

Sources: Bloomberg and Wells Fargo Investment Institute. For illustrative purposes only. Investment grade represented by Bloomberg Barclays U.S. Aggregate Bond Index, which is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market. High yield is represented by Bloomberg Barclays U.S. Corporate High Yield Bond Index , which measures the USD-denominated, high yield, fixed-rate corporate bond market. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Option-adjusted spread is the difference in yield over equivalent-duration Treasuries. Shaded area indicates a recession as designated by the National Bureau of Economic Research. Data as of March 31, 2018.

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2. Investor complacency

Late in a long bull-market run, investors may remain calm even during bouts of volatility. Many have become accustomed to a stock market that continues to climb higher.

What we’re seeing

Earlier this year, when the S&P 500® Index experienced its first correction in a few years, many investors appeared to be taken by surprise.

We believe that investors should be on guard for further periods of volatility and maintain a diversified portfolio in line with their longer-term investment plan.

 

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3. Rising interest rates

As the economy strengthens, the Federal Reserve (Fed) raises rates to prevent the economy from overheating and inflation from accelerating.

What we’re seeing

Currently, short-term interest rates are increasing but are not considered restrictive.

A key signal of an impending recession is when the yield curve inverts, such as when the 2-year U.S. Treasury note has a higher yield than the 10-year U.S. Treasury note. While every recession has been preceded by an inverted yield curve, not every inverted yield curve has led to a recession.

As shown here, the spread between 2-year and 10-year Treasury securities has tightened but has not yet inverted.

 

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The yield curve has flattened but has not inverted

Sources: Bloomberg and Wells Fargo Investment Institute. Series represents the difference between the constant-maturity 10-year U.S. Treasury and the constant-maturity 2-year U.S. Treasury. For illustrative purposes only. Yields represent past performance and fluctuate with market conditions. Current yields may be higher or lower than those quoted. Past performance is no guarantee of future results. One basis point equals 100 basis points. Shaded area indicates a recession as designated by the National Bureau of Economic Research. Data as of March 31, 2018.

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4. Potential asset bubbles

When valuations rise above historical averages, investors are buying equities at a premium price, which may result in asset bubbles.

What we’re seeing

Currently we are not seeing signs of asset bubbles, and believe that most markets are fairly valued at this time.

However, new cash tends to enter the equity market in the later stages of a bull-market run, due to investors’ fear of missing out on market gains.

Such inflows tend to drive up price levels ahead of fundamental measures, like earnings.

 

View the strategies for an extended bull market

 

Strategies for an Extended Bull Market

The best — and most difficult — time to prepare for a bear market is before the bull market has reached its end. What strategies are worth considering in today’s market?

    Late bull markets can be lucrative

    In our estimation, a recession in the U.S. is not likely over the next 12 to 18 months. And our research shows that the final stages of a bull market can be lucrative for equity investors.

    Investors might consider globalizing their portfolios if they haven’t already done so.

    As the chart here shows, international markets may not be as far along in their economic and stock market cycles as the U.S.

    This means that their stock markets might continue to climb even if the U.S. stock market takes a pause in the coming years.

    Other developed market equities have lagged U.S. equities

    Sources: Bloomberg and Wells Fargo Investment Institute, as of March 31, 2018. For illustrative purposes only. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. The S&P 500 Index is a market capitalization-weighted index considered representative of the U.S. stock market. The MSCI EAFE Index is an equity index that captures large- and mid-cap representation across developed market countries around the world, excluding the U.S. and Canada.

    The most lucrative sectors tend to shift

    As the bull market peaks and transitions to a bear market, sector leadership typically changes.

    Because inflation tends to rise near the end of a bull market, natural inflation-hedged sectors like Materials may perform well.

    During a bear market, the sectors that tend to hold their value best are those that are more defensive in nature.

    Cyclical sectors favored in an early bull market include consumer staples, health care, and financials; mid bull markets favor consumer discretionary and industrials; and late to peak bull markets favor industrials, energy, and materials. Defensive sectors favored at the beginning of a bear market include utilities, consumer staples, energy, and health care.

    Active can outperform

    Our research shows that about half of all mutual funds in Morningstar Inc.’s database outperformed their benchmarks in 2017, making it the best year for active management since 2012.

    Relative performance was especially strong for U.S. large-cap value, international equity, and U.S. fixed-income funds.*

    We believe that a blended approach — including a mix of active and passive strategies — may be suitable for many portfolios, depending on an investor’s risk profile and return objectives.

    *Source: Wells Fargo Investment Institute, “Active Management Rebounds in 2017; Prospects Remain Positive for 2018,” January 25, 2018.

    Diversification can counter equity volatility

    Asset classes such as fixed income and alternative investments (for qualified investors) can help counter potential equity volatility.

    In particular, we believe that hedge funds could benefit in 2018 from an improved environment for active management.

    As shown here, since 1990, hedge funds have held up better than global equity indices in down markets, capturing just 18% of the losses equities sustained; in up markets, hedge funds have captured 53% of positive equity returns.

    Hedge funds can help investors win by not losing

    Up/Down Market Capture Ratios are a measure of investment performance in up and down markets relative to the market itself. A down market is one in which the index’s quarterly return is less than zero.

    Sources: Morningstar Direct and Wells Fargo Investment Institute, December 1, 1990, to March 31, 2018. For illustrative purposes only. Index returns represent general market results, assume the reinvestment of dividends and other distributions, and do not reflect the impact of any fees, expenses or taxes applicable to an actual investment. Unlike most asset class indices, HFR Index returns reflect deduction for fees and expenses. Because the HFR indices are calculated based on information that is voluntarily provided actual returns may be higher or lower than those reported. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results. Diversification does not guarantee investment returns or eliminate risk of loss including in a declining market.

    Hedge funds are represented by the HFRI Fund Weighted Composite Index. Global equities are represented by the MSCI World Index. The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2000 single-manager funds that report to HFR Database. Constituent funds report monthly net-of-all-fees performance in U.S. dollars and have a minimum of $50 Million under management or a 12-month track record of active performance. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of 23 developed market countries including the United States. Alternative investments, such as hedge funds, are not suitable for all investors and are open only to accredited or qualified investors within the meaning of the U.S. securities laws. Please see the end of this report for some of the risks associated with this asset class.

More Questions, Answered

The full Investing Late in a Bull Market report lets you know:

  • How close we think we are to the end of this equity bull market

  • How investors typically behave toward the end of an upcycle

  • How asset classes have performed late in the cycle and how performance shifts when an equity bear market occurs

Plus, you’ll find the five actions that may help you prepare for the next bear market.

View the Full Report

Investment Expertise and Advice to Help Clients Succeed Financially

Wells Fargo Investment Institute is home to more than 100 investment professionals focused on investment strategy, asset allocation, portfolio management, manager reviews, and alternative investments. Its mission is to deliver timely, actionable advice that can help investors achieve their financial goals.

For additional investment insights and timely market commentary, visit our website. For assistance with your investment planning or to discuss the points in this report, please talk to your investment professional.

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