Wall Street Agrees On When The Bull Market Will Finally End

US stock indexes remain at record highs, and volatility near its lows, despite signs that their recordsetting run is losing steam as it becomes increasingly dependent on a narrow band of stocks. Indeed, signs that the rally is running on fumes have convinced portfolio managers and Wall Street strategists that the second-longest bull market of all time will be over in less than 18 months, while a similarly longstanding rally in bonds is also nearly ready to roll over, according to a Bloomberg survey of fund managers and strategists.

“The poll of 30 finance professionals on four continents showed a lack of consensus on the asset judged as most vulnerable now, with answers ranging from European high yield to local-currency emerging-market debt - though they were mostly in the bond world. Among 25 responding to a question on the next U.S. recession, the median answer was the first half of 2019.”

Of the 21 participants who responded to Bloomberg's question of when they see a slide of more than 20 percent for the S&P 500 Index, the median response was the fourth quarter of 2018. Two forecast that the bear market would begin during the final three months of this year. Of the 21 respondents who forecast a bear market for credit, defined as a 1 percentage point jump in the premiums of US investment-grade corporate bond yields over comparable government-debt yields, the median pick was the third quarter of 2018.

According to Bloomberg, many of these strategists and portfolio managers see central bank policy as the lynchpin of their thesis, believing that years of easy-money policies have artificially inflated stock and bond valuations. By the beginning of 2019, US interest rates will have risen another 1.5 to 2 percentage points, and the central bank will have unwound at least part of the $4.5 trillion in Treasuries and MBS that the Fed purchased during the recession. Of course, this is hardly a coincidence, as Remi Olu-Pitan, who manages a multi-asset fund at Schroder Investment Management Ltd. in London, explains.

Furthermore, it’s widely expected that the Bank of England, European Central Bank and the Bank of Japan will all have begun tapering asset purchases, raising interest rates – or possibly both. The Bank of Canada has already shocked market strategists by raising its benchmark rate for the first time in seve years, which it did earlier this month.

“Consequences could be very painful,” Olu-Pitan said. “We have had a liquidity-fueled bull market. If that is taken away, there is a pressure point,” she said.

Indeed, in a version of a chart that we’ve presented many times, there’s a tight correlation between equity gains and global central-bank stimulus.

None of the poll’s respondents expect a 2007-2009 style meltdown. But as is depicted by Bloomberg in the chart below, the 2002 bear market in US stocks wiped out more than $7 trillion of value.

To be sure, some Wall Street strategists believe a downturn in stock and bond markets could begin as soon as the third or fourth quarter of 2017.

According to Bank of America strategist Michael Hartnett, risks for equities are set to multiply in the third and fourth quarters. Hartnett said in a note published earlier this month that "the most dangerous moment for markets will be when rising rates combine in three or four months’ time with an inflection point in corporate profits. In anticipation of this, we would use the next couple of months to buy volatility, and within fixed income slowly reduce exposure to IG, HY, and EM bonds."

Atul Lele, chief investment officer at Nassau, Bahamas-based Deltec International Group, was the only respondent to the poll who ranked an economic collapse in China as his primary concern, followed by excessive Fed tightening.

All eyes are on the Fed this week as it prepares to deliver its July policy update on Wednesday. Investors will be looking for clues about when the great balance-sheet unwind will begin, after New York Fed Governor William Dudley, along with a few other officials, said that process would begin later this year.