Investors love a rising stock market, but experienced investors recognize it can be a mixed blessing. The longer a bull market lasts, the closer the next bear market becomes.
This is worth thinking about now, because the current bull market has lasted for a very long time but is showing its age recently with some wild volatility. Has the bull market reached its expiration date -- and, if it has, what can you do about it?
Consider current trends
The following are some characteristics that might make you cautious about the current stock market:
- The stock market and economic cycles are both pretty long in the tooth
The last bear market began in late 2007 and stocks hit bottom in March of 2009. That means the current stock market cycle is 11 years old, with the bull market phase of that cycle now more than nine and a half years old. According to the Economist, market cycles have historically lasted an average of 6.8 years, with bull markets averaging 5.1 years. In other words, this has already been a much longer cycle and bull market than the norm.
The timing of the current business cycle is similar to that of the stock market cycle. The last recession began in December of 2007 and ended in June of 2009. That means the full cycle is now close to 11 years old, with the current expansion lasting nearly nine and a half years. To put that in perspective, since the end of World War II, the average economic cycle has lasted less than six years, with the average expansion phase lasting less than five years. Thus, this has already been an extraordinarily long expansion.
Of course, there is no time limit to how long a stock market cycle or an economic cycle can last. However, the longer they last, the more you are counting on beating the odds if you expect them to continue even further.
- Stock prices have outpaced earnings
The stock market has been strong in recent years, but that's not necessarily reason to draw comfort from it. The problem is, prices have risen more than the underlying value of stocks.
Over the past five years, aggregate earnings of the S&P 500 rose by 36.91 percent. That's good; but over the same time, the price of the S&P 500 rose by 69.23 percent. This means investors are paying more for every dollar of earnings they get from these stocks. That's the kind of thing that can lead to a downward correction in prices, or at best a period of lackluster returns while earnings catch up to inflated stock prices.
- Investors have gotten more aggressive
According to the Employee Benefit Research Institute (EBRI), 401(k) investments are now more aggressively allocated than they were at the end of the previous market cycle. From 2007 to 2016, the percentage of 401(k) participants who were heavily invested (at least 80 percent) in stocks rose from 44 percent to 48 percent.
Young people in particular have gotten more aggressive. According to the EBRI, three-quarters of 401(k) participants in their 20s now have 80 percent or more in stocks, compared with less than half back in 2007.
What this means is that, as devastating as the financial crisis was, 401(k) investors have more to lose today than they did going into that crisis. Investors who are currently in their 20s probably had little or no first-hand investment experience through the financial crisis, so their risk-taking today is not informed by it.
- Interest rates are rising
Low interest rates are good for stocks -- they stimulate the economy in general, and they make stocks seem more affordable by comparison. Much of the current bull market has been aided by extraordinarily low interest rates.
Things could change now that interest rates are rising. At the very least this creates a headwind for stocks, making strong price increases more difficult unless they are accompanied by equally strong earnings growth.
Worried about the stock market cycle? Here's what you can do
Here are four things to do if you think the bull market may be nearing its expiration date:
- Rebalance your asset allocation
Strong equity performance may have pushed your stock allocation to a higher percentage than it was a few years back. This would be a good time to rebalance it back to your target allocation.
- Direct new contributions to more conservative investments
If you can't bring yourself to sell stocks just now, at least consider putting your new investments into less aggressive vehicles. This will help you gradually ease down the risk of your portfolio.
- Stress-test your retirement savings plan
Use a retirement calculator to see what impact a 20 percent decline in your investments would have on your retirement plan. If you are young, having many years ahead of you to make up for that decline will probably mean a bear market now would have a relatively small impact on your long-term plan. However, if you are nearing retirement, the potential impact of a big decline at this point might prompt you to reduce your investment risk level.
- Beef up your emergency fund
One of the worst financial moves you can make is to have to tap into long-term assets when their prices are down. This can mean locking in losses and leave you with less money invested to recover from the downturn. One way to protect against this is to make sure you have an emergency fund that is deep enough to cover unexpected expenses. The good news is that, with rates on savings accounts finally rising, if you shop for one of the better savings accounts, you can actually get paid a decent amount of interest while you keep this money set aside.
Stock market cycles are inevitable, but that doesn't mean you can't do anything about them. Understanding the cyclical nature of the market can help you avoid getting too aggressive when stocks are high and too cautious after they've already fallen.
More resources for investors:
Emergency funds: Why opening multiple money market accounts is a smart move
How much money do you need to retire? Use our retirement calculator