More than six years into this equity rally, investors are starting to wonder whether the bull market is getting a little long in the tooth.
Citigroup's Stephen Antczak, head of U.S. credit strategy, William Lee, chief U.S. economist, and credit strategist Jung Lee examined a variety of market metrics that provide clues as to when the current cycle will reach its best-before date.
The typical business cycle over the past three decades, they note, has usually lasted nine years from trough to trough.
The market is currently suggesting that the United States is about 70 per cent through its recovery phase.
"This implies that the economy may peak in Q3 2017," Citi's team writes.
The metrics the team examined were credit spreads and curves, forward price-to-earnings ratios, commercial real estate price appreciation, and consumer confidence.
The forward price-to-earnings ratio on the S&P 500, for instance, is consistent with a recovery that it is approximately three-quarters from its finale:
As a caveat, the sample size examined is quite small, consisting of only three market cycles.
But just because we may be closer to the end of a bull market than the beginning isn't cause to liquidate riskier holdings.
In the final 30 per cent of a recovery, stocks typically outperform bonds, both of the high-grade (rated AA or better) and the high yield (below investment grade) varieties.
Since the 1980s, the S&P 500 has posted annualized total returns of nearly 13 per cent, on average, once past the 70 per cent mark of a recovery.
"But that said, when we look at how equity performed in periods prior to the '80s (note that historical data in the equity market goes back much further than in credit), we find that stock market performance was more subdued," Citi's team wrote. "Said differently, return variance is dramatic, so do not get too optimistic…"
Corporate debt has provided positive but smaller returns over similar stretches.
With regards to the outlook for corporate credit, Citi's invokes the scariest four-word phrase in finance: "this time is different."
Both high-grade and high-yield corporate spreads are wider than normal for the 70-per-cent mark of a recovery.
"This means that spreads may have less room to widen as we move to the economic peak than in the past," they write.
Against the backdrop of historically low bond yields, however, it's also equally valid to make the argument that the low level of corporate yields in absolute terms is unsustainable. Weakness in this segment could be more acute than in prior recovery periods in the event of a faster than anticipated glide path higher for the federal funds rate that roils fixed income markets.
Citi isn't claiming that a market peak within three years is set in stone – their economists actually think the U.S. recovery has much more room to run.
"Our economists believe that the recovery period is far from being over," the trio writes. "Businesses are not overextended, consumers have delivered considerably from post-Crisis peaks, and obviously monetary policy is accommodative."
What's more, there has been little in the way of a housing upcycle. As Edward Leamer pointed out in his acclaimed paper, Housing Is The Business Cycle, a drop-off in residential investment "offers by far the best early warning sign of an oncoming recession" compared to other components of GDP. What doesn't go up is far less likely to come down. The demographics stateside support a pick-up in homebuilding, all the more so given the robust labour market gains realized over the past year and low interest-rate environment.
"With the federal funds rate still at zero, the current and prospective monetary policy stance is years away from 'choking off' growth," says Citigroup.