Even if it's past 'peak happiness,' this bull market shows signs of sticking around

  • Earnings are on pace to grow more than 15 percent this year, and if 2019 can nudge profits incrementally higher as the economy avoids recession, stocks could still reach fresh highs.
  • Momentum, the statistical measure of the pace of the rally's increase, very likely peaked in January near all-time record levels.
  • Public excitement over stocks became fevered entering the year, as the tax-cut passage made the bullish case far more intuitive and linear after an already-strong year for stocks.
Michael Nagle | Bloomberg | Getty Images

Stocks are showing signs of finding their footing after two months of struggle. For now, the major indexes have held above their February low points and most evidence indicates they are still in a fairly typical correction within a long-term climb rather than entering a deep, prolonged downturn.

Still — even if the market starts making headway again toward its January high-water mark — it is possible Wall Street has passed its moment of "peak happiness" for a while – and perhaps for this entire cycle.

That is to say, several investment factors are likely near, or past, their best levels for this cycle. Among them: equity valuation, market momentum, risk appetite, financial liquidity and investor optimism.

But, importantly, if this is indeed the case, it doesn't necessarily mean the market itself has already peaked. Growing earnings and a new growth phase of the economic expansion can carry stocks higher still, even if the "peak happiness" point occurred in January.

The market's price-to-earnings ratio (based on the latest 12 months reported results) raced higher in late 2017 and through January on growth-stock leadership and enthusiasm over tax-cut-juiced profit windfalls for companies. The multiple reached its peak for this bull market at 23.4, well above the five-year average of 18, and has since retreated below 20.

That 23.4 level might prove the apex for this cycle. Yet earnings are on pace to grow more than 15 percent this year, and if 2019 can nudge profits incrementally higher as the economy avoids recession, stocks could still be carried to fresh highs on the strength of the "E" in the P/E.

Momentum — the statistical measure of the pace of the rally's increase — very likely peaked in January near all-time record levels. The relative strength index essentially tracks that rate of change. Yet, as described here, a bull-market's ultimate price peak typically comes a good deal after its hottest momentum phase.

Financial conditions were extraordinarily "loose" near the January peak, meaning liquidity was cheap and plentiful, risk spreads on corporate debt were low and market volatility tame. The Goldman Sachs Financial Conditions Index shows conditions easing as the line gets lower, and here shows a sharp tightening — albeit from very accommodative levels.

This gets at the broad backdrop for risk-taking, and certainly can relax as markets stabilize, and are still very consistent with a strong risk-taking environment that can support equities. But with the Fed looking at more rate hikes and credit spreads already near their tightest levels of the cycle, it's tough to see how liquidity would become much more loose than it was two months ago.

Public excitement over stocks became fevered entering the year, as the tax-cut passage made the bullish case far more intuitive and linear after an already-strong year for stocks. Whether measured by retail-broker account openings, household equity exposure or surveys, investors were crowded on the bullish side of the boat.

This shows the ratio of bulls to bears among investment-newsletter writers in the long-running weekly Investors Intelligence poll.

Here again, bull markets have tended to carry on a while — even years of fresh record highs — after the bull/ratio peaks for a cycle. This was true in the '80s, late-'90s and mid-2000s.

Taken together, this suggests the easiest, most effortless phase of the bull market might have reached a crescendo in January. And they show how steep a climb it would be to get back to that particular formula for rapid and sustained gains.

But if this economic cycle indeed has another extended leg in — as plenty of indicators suggest — and companies can keep the profit machine running along with stock buybacks and mergers, there's no saying the market as a whole can't work its way a good deal higher before it reaches its ultimate peak.