Bull market turns two: How far we've come, and what's next?

Key Takeaways

• Last week marked the two-year anniversary of the current bull market, with stocks gaining about 60% since 2022. Historically, most bull markets make it to the end of year three, but returns tend to moderate. We expect the same this time, as fundamental conditions are still solid but slowing.
• While September inflation came in slightly hotter than expected, it's unlikely to stop the Fed from continuing its easing campaign. We anticipate quarter-point rate cuts at each meeting until Fed policy settles around 3% - 3.5%.
• Valuations have limited room to increase further, and therefore earnings will likely have to carry the heavy load if markets are to build on their gains. As the third-quarter earnings season kicks off, we look for more signs of earnings broadening that can support the recent leadership rotation.

Two years ago, on October 12, 2022, inflation was above 8%, the Fed was in the midst of a historically aggressive rate-hiking campaign, and the S&P 500 had dropped 25% off its high1. However, as is often the case, widespread pessimism at the time gave way to a new bull market, which continues to this day. Since then, stocks have gained 60%, and the S&P 500 has reached 45 new record highs1.

As we mark the two-year anniversary of the bull market, a key milestone, we assess how the economic and market environment has evolved, and we explore what might come next.

Performance

• How far have we come?

The short answer: a long way. U.S. large-cap stocks increased 24% in the first year after the October 2022 low and gained another 35% in the second year, which wrapped up last week. While the combined 60% gain may seem excessive at first glance, it is right in line with the historical average of the past 11 bull markets going back to 19572.

Source: Morningstar, Edward Jones. The graph shows the S&P 500 gains in the first two years of a bull market. The 60% return since 2022 is not outsized relative to history. Past performance does not guarantee future results. An index is unmanaged, cannot be invested into directly and is not meant to depict an actual investment.

• What’s next??

Geopolitical uncertainty and the U.S. election might be sources of short-term volatility, but history offers reasons for optimism. The average duration of the last 11 bull markets has been nearly five years, with most of them (eight out of 11) making it to the end of the third year2. This suggests that the current bull might still be in its early or middle phase. However, year three might not be a smooth ride. Returns tend to moderate, with stocks advancing only half the time, while in the other half stocks pulled back to catch their breath. From a fundamental perspective, it will be the outlook for growth, interest rates and corporate profits that will likely determine outcomes. So, let's dive into these factors.

Source: FactSet and Edward Jones. S&P 500 Price Index. The graph shows the strength and length of past bull markets. Past performance does not guarantee future results. An index is unmanaged, cannot be invested into directly and is not meant to depict an actual investment.

Economic growth

• How far have we come?

In the first half of 2022 the U.S. economy hit a soft patch, experiencing a mild contraction in the first quarter and barely positive growth in the second quarter. But since then, GDP growth has been averaging a strong 3% over the past two years and, according to the Atlanta Fed's real-time estimate, is on track to post a 3.2% gain in the third quarter1. Despite the strong headwinds of high inflation and high borrowing costs, the most anticipated recession in recent history never materialized, as the consumer, the main cylinder of the U.S. economic engine, has remained resilient. Reasons for that include the healthy household balance sheets after more than a decade of deleveraging, the boost in excess savings from government fiscal support, a strong labor market, and record wealth boosted by significant appreciation in real estate and equity prices. ?

• What’s next?

We expect growth to slow in the quarters ahead toward a pace consistent with or slightly below the economy's long-term potential rate, which is considered to be around 2%, based on labor force and productivity growth. The potential of artificial intelligence to boost productivity across many different sectors could push long-run growth up to 2.5%, but that outcome is not guaranteed and will likely take time. A slowing but still growing economy can provide a favorable foundation for corporate profits to continue to rise, which in turn can help sustain the bull market.

Inflation & the Fed

• How far have we come?

The spike in inflation to a 40-year high in the summer of 2022 has been a defining feature of the post-pandemic economy, leading the Fed to sharply increase borrowing costs to tame it. Given that inflation trends and Fed action have been the most important market drivers in this cycle, it is not a coincidence that stocks bottomed as inflation peaked. While headline inflation crested in June 2022 at 9.1%, core inflation, which excludes the volatile categories of food and energy, didn't peak until the October release of the September reading at 6.6%. Fast forward to today, and headline inflation sits at 2.4% and core inflation at 3.3%, showcasing the significant progress made1.

Source: Bloomberg, Edward Jones. The graph shows the decline in inflation since 2022 which is allowing the Fed to start lowering its policy rate.

• What’s next?

Last month the Fed made a decisive step in starting to normalize its policy rate by delivering its first rate cut of this cycle, lowering interest rates by a larger-than-typical half a percentage point (0.5%). While last week's inflation came in slightly hotter than expected, it's unlikely to stop the Fed from continuing its easing campaign, as it has now shifted its focus from inflation to the labor market. We think further moderation in housing costs and cooling wage growth will likely apply downward pressures to prices ahead, helping bring inflation to target next year. As CPI inches to 2%, the Fed will want to gradually remove its restriction and keep the chances of a soft landing alive. ?

In our view, the Fed will cut rates by a quarter point at each meeting until its policy settles around 3% - 3.5%. Even as the path of least resistance for inflation and interest rates is likely lower over the next 12 months, policymakers will be sensitive to any bumps in the disinflationary story. We are mindful of the fact that inflation during the third year of a bull market has on average bottomed and started to perk up, which is a key risk to monitor in 2025.

Earnings & market leadership

• How far have we come?

Driving the nearly 60% stock-market gain has been a combination of growth in corporate earnings and valuation expansion. More specifically, S&P 500 profits have risen about 15% over the past two years, reaching new records, while the price-to-earnings ratio has increased by 45% (from 15 to 21.5)3. ?

While the market gains in these two years are right in line with the average bull-market gains, the asset class, style and sector leadership are in many ways unique. When examining the past 11 bull markets, this is the only time off a two-year low that the "average" stock, as proxied by the S&P 500 equal-weight index, has not outperformed the market-cap weighted index. We have also seen the biggest outperformance of growth-style investments relative to value, as excitement around artificial intelligence has boosted valuations for the mega-cap tech stocks, leaving other parts of the equity market behind. To this end, the small-cap gains have been less than half of what is typically observed at the start of a new bull2. ?

• What’s next?

It is encouraging that market leadership has started to broaden more recently beyond the last two-year winners, potentially providing more room for stocks to run. Our view is that valuations have limited room to grow further from here, and therefore earnings will likely have to carry the heavy load if markets are to build on their two-year rally. ?

The third-quarter earnings season kicked off last Friday, with some of the big U.S. banks reporting better-than-expected results. Consensus expects earnings for the quarter to grow 4.2%, the fifth consecutive quarter of growth3. A key trend to watch is whether an expected slowdown in earnings of the Magnificent 7 group of stocks coincides with a pickup in earnings growth from the rest of the market, or the S&P 493. If that happens, leadership will continue to broaden, with cyclical sectors and value-style investments starting to make up some of the lost ground. Backed by a resilient economy, we project corporate profits to rise again next year, but possibly less than the 15% earnings growth analysts have penciled in, which appears a bit optimistic3.

Source: Morningstar, Edward Jones. The graph shows that the Equal weight S&P 500 has outperformed the market-cap S&P 500 in the first two years of a bull market every time since 1974 with the exception of the current bull. Past performance does not guarantee future results. An index is unmanaged, cannot be invested into directly and is not meant to depict an actual investment.

The bottom line

Investor pessimism, growth concerns, and uncertainty around inflation two years ago have given way to economic resilience, easing price pressures, and excitement around artificial intelligence, marking the transition to a new bull market. As the old adage goes, bull markets don't die of old age, but from a recession, overly tight Fed policy, or an external shock. The latter is impossible to predict, but with the odds of a recession decreasing and the Fed embarking on a rate-cutting cycle amid a healthy labor market, we expect the bull market to continue into its third year.

However, elevated valuations, geopolitical risks in the Middle East, and a tight U.S. presidential election could act as catalysts for short-term volatility. That said, any potential pullbacks should be seen through the lens of a longer-term uptrend in stocks, which is still supported by solid fundamental conditions.

Read the full Weekly Wrap here: https://www.edwardjones.com/us-en/market-news-insights/stock-market-news/stock-market-weekly-update

Source: 1. Bloomberg, 2. Morningstar, Edward Jones, 3. FactSet

Important Information:

The Weekly Market Update is published every Friday, after market close.

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