Our starting point for developed-market equities is that we are not in a new secular bull market. Extended bull markets typically happen when: 1) the starting point valuation is very attractive; 2) growth is strong and sustained, and 3) credit is readily available, allowing greater use of leverage. None of these factors seems likely in this cycle. Once the current rally ends, we expect an extended period of choppy markets. Exhibit 1 shows a stylized picture of how this could play out (taken from Teun Draaisma's report entitled The Aftermath of Secular Bear Markets, 10 August).
What is likely to end the rally? We think the biggest risk is growth and earnings disappointment. As is typical, an expanding PE ratio led the rally. The PE expands from a market low due to improving risk appetite and investors factoring in better earnings to come. Next year equities will have to become more earnings-led, again as is typical.
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