Cyclically, U.S. equity market behavior resembles a late-stage bull market, characterized by narrowing breadth and declining correlations.
One of two cyclical scenarios is likely to play out on a 6-12 month horizon. The preferred scenario of our U.S. Investment Strategy service is that the cyclical bull market persists in 2015, as the “generous liquidity” stage only slowly transitions to an earnings growth driven phase, keeping U.S. macro volatility low. In this case, the late-stage bull will be characterized by narrowing breadth, with yield plays a potential bubble candidate as Treasury yields respond to weakness abroad and dollar strength.
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This pattern of narrowing breadth played out during both the NASDAQ and housing bubbles. The former bubble in the late 1990s is particularly instructive for the current environment, because it was given a jumpstart by weakness abroad that kept the Fed generous. In 1998, with the help of the “Greenspan put”, healthcare, consumer staples, banks and technology were all bull market leaders. But by 1999, only tech was rising.
Alternatively, a cyclical bear market could begin in response to Fed tightening and/or EM deflation, if they are sufficiently intense and prolonged. Granted, the Treasury yield curve is flattening and earnings revisions are the most negative in 24 months.
Nevertheless, it seems too soon to expect a bear market. The oil price plunge increases the Fed’s room for maneuver by widening the wedge between economic growth and inflation.
Even if a cyclical bear market does not emerge next year, intermediate-term forces are gathering for a potentially severe correction.
Related:
Technician: Violent Corrections Typical of Late-Stage Bull Markets; Focus on Large-Caps
