Apparently, “periodical” cicadas focus on the growth cycles of the trees that they feed on through the roots during the spring budding process. That is what they count for 13 or 17 years, but no one knows why. Also, this co-emergence of cicadas has not happened in 221 years! Earnings cycles, bull and bear market cycles, and presidential cycles all have their own rhythms as well. Long-term interest rates, stock market and economic cycles can span long periods of time, but economic and stock market cycles don’t necessarily coincide.
The average post-war economic expansion has lasted about 64 months, but ranged from 12 to 128 months. We are about 50 months into this current expansion. The average economic contraction has lasted about 10 months, but ranged from 8-18 months in length. The average bull market period since 1932 has lasted nearly 5 years with an average cumulative total return of 178%. The average bear market has lasted about 1.5 years with an average cumulative loss of -35%. It seems a distant memory that the S&P 500 dropped -19% in 2022 and the technology heavy Nasdaq dropped -33% after several strong years.
P/E ratios are cyclical also, with the ratio peaking with Fed rate-hiking cycles in 1987, 1994, 2000 and 2021. In a long cycle, the price to earnings ratio of the S&P 500 rose between 1982 and 2000 from 7x to 22x as interest rates dropped from 16% to 5%. There were peaks and valleys during that 18-year period, but the clear trend in valuations was up, aided by a technology innovation cycle. From 2009 until now, the P/E ratio of the S&P 500 has risen from about 10x forward earnings to about 21x as interest rates continued a general downward trend, that is until the Fed starting hiking rates in 2022.
The yield curve is still predicting a recession due to long rates being lower than short rates. You have to go back to Fed Chairman Paul Volcker’s rate hikes in late 1979 and the early 1980’s to see the curve this inverted. At least now we appear to be closer to the end of the U.S. rate-hiking cycle, although that has been pushed out this year as inflation has been stubbornly high.
Yesterday, Canada became the first of the Group of Seven central banks to start easing its interest rates. The European Central Bank may follow through with an interest rate cut of a quarter-point today. Meanwhile, the U.S. 10-year yield has fallen from 4.6% to about 4.3% in the past week and stock indexes are again trading at new highs.
The Institute for Supply Chain Management (ISM) Services Index came in at 53.8%, beating estimates for 51.0% after a disappointing 49.4% the previous month. The U.S. services sector expanded in May by the most in nine months. Readings above 50 typically indicate expansion. This measure provides some reassurance for the economy after several recent reports of weaker data. The majority of respondents to the services index survey indicated that inflation and interest rates are still impediments to improving business conditions. Thirteen industries reported growth in May, led by real estate and health care, while five sectors, including retail trade, pointed to a decline.
On the goods-producing front, the ISM said its manufacturing gauge dropped to a three-month low as orders fell by the most in almost two years and production was stagnant. The economy got off to an uninspiring start in the first quarter at just 1.3% GDP growth, the slowest performance since 2022. The latest forecast for second quarter GDP was just revised down from over 3% a month ago to 1.8%. The trend toward spending on services over goods continues.
Resilient earnings and good-enough economic data continue to support the global equities rally that
began last year. The possibility of a Fed monetary policy mistake, stubborn inflation, disappointing earnings results, U.S. fiscal spending and debt concerns, geopolitical tensions, and contentious elections all pose risks to the rally. It will be interesting to see whether we continue to get a harmonious and positive emergence from this interest rate hiking cycle or a mouth full of bugs. At least we know the insects won’t last long.
Birthdays: Actor Paul Giamatti turns 57, Carol Baskin turns 63 (if you watched “Tiger King” during Covid), and Comedian Colin Quinn (SNL) turns 65.
Christopher Crooks, CFA®, CFP® 610-260-2219