The bull market is nearing its second birthday. Here's why it will likely continue.

By Joseph Adinolfi

Most bull markets since the end of World War II that have lasted at least two years have continued through year three

The bull market in U.S. stocks is about to turn two years old, the latest milestone for a rally that has surpassed the expectations of all but the most bullish investors on Wall Street.

The S&P 500 SPX has climbed more than 60% since Oct. 12, 2022, when the index hit its bear-market closing low of 3,577.03, according to FactSet data. These gains have unfolded much faster than many financial professionals had anticipated, pushing Wall Street firms to repeatedly raise their year-end targets to keep up.

See: Why Goldman Sachs has bumped up its S&P 500 target for the third time this year

The data paint a picture of a bull market showing few signs of slowing down, even if the path higher has gotten a bit more bumpy over the past three months. The Cboe Volatility Index VIX, known as the VIX or as Wall Street's "fear gauge," touched its highest level intraday since March 2020 during a global market meltdown on Aug. 5, according to FactSet data. But the jump in the fear gauge quickly receded as stocks bounced back. A similar slump followed during the first week of September, but that dip also attracted more demand from investors looking to pick up stocks at a discount.

Since then, the S&P 500 has capped off its best performance during the first three quarters of the year since the late 1990s. And if it can hold on to its gains until the end of December, it would mark the second straight year in which the S&P 500 has risen by 20% or more - the first time it will have achieved such a feat since 1998, Dow Jones Market Data show.

But the potential risks to the rally have multiplied recently. U.S. stocks are currently sitting on valuations that are high relative to history and just shy of their previous peak from late 2021.

Geopolitical risks are percolating once again, as renewed conflict between Israel and Iran has pushed crude-oil prices higher and left stock investors on tenterhooks.

And as the third-quarter earnings season begins, investors will likely cast a critical eye toward reports from Microsoft Corp. (MSFT), Alphabet Inc. (GOOG) (GOOGL) and the other artificial-intelligence "hyperscalers" for any clues about how long it might take for these companies' massive investments in AI technology to pay off. Later on, same investors will get a look at earnings from Nvidia Corp. (NVDA). When the company reported its last round of results in August, those results, although strong, weren't strong enough to boost shares.

Finally, the U.S. election on Nov. 5 has many traders buying hedges that would protect their portfolios from any volatility that might result from a race that could come down to the wire and potentially involve a contested result.

Because of all this uncertainty, millions of investors around the world are looking for guidance about where the market might be headed next.

A team of analysts at Ned Davis Research decided to dig into this question by closely examining how bull runs have fared in the past after making it to their second birthday.

They found that, since the end of World War II, there have been 12 bull markets that lasted at least that long. The current one would be the 13th, barring a massive selloff between now and the end of the week.

Seven of those made it to the end of their third year, suggesting that the chances that the current bull run will continue are in investors' favor.

The median two-year advance for all 12 runs was 54.4%, according to Ned Davis, which means that the gains that stocks have seen over the past two years actually aren't that extraordinary relative to history.

But going forward, things get a bit murkier. Rallies that made it to their third birthday saw a median gain of 13.3% during their third year, according to the Ned Davis team. Those that didn't saw a pullback of minus 5.9%.

Bull markets don't die of old age

Not a single example from the Ned Davis analysis featured a bull market dying of old age. In every case where the bull market fizzled, the selloff was brought about by one catalyst or another.

Recession was the most common, arriving to kill bull markets in their third year on three separate occasions. A fourth example saw the bull market that began in October 1966 killed by the Federal Reserve when the central bank started to tighten monetary policy to fend off a bout of inflation.

The fifth example was the bull run that began in March 2009. That time, it was Standard & Poor's downgrade of the U.S. credit rating, as well as global jitters tied to the European sovereign-debt crisis, that sent stocks sliding.

The Ned Davis team expects the current bull run to make it to its third birthday as long as three things go right.

First, the disinflationary trend that started in late 2022 must continue. Since the Fed delivered its jumbo interest-rate cut last month, worries about a potential revival of inflation have been creeping back into the market. If investors see concrete signs that inflation has reaccelerated, it could provoke a market tantrum.

Second, the Fed must succeed in pulling off a soft landing for the U.S. economy. That means the central bank must thread the needle and deliver slightly slower - but still positive - economic growth while driving inflation back to its 2% target.

If a recession begins instead, it would likely send stocks sliding. But the Ned Davis economic team sees few reasons to worry about that right now.

Third, the largest U.S. companies must continue to grow their earnings. Wall Street expects earnings growth from the Magnificent Seven - an elite group of megacap companies expected to see substantial benefits from the advent of AI - to slow starting later this year.

The rest of the companies in the index will need to pick up the slack, and forecasts suggest this will likely happen. But forecasts are subject to change, and much will ultimately depend on how well the economy holds up between now and this time next year.

U.S. stocks are off to a weak start in October, with the S&P 500 down 0.6% since the start of the month, according to data from LSEG. The index stood at 5,729 in early afternoon trading on Monday, down 0.4% on the day.

Other major U.S. indexes were not faring much better. The Nasdaq Composite COMP has fallen 0.7% since the start of October and was down 0.3% at 19,474 on Monday. The Dow Jones Industrial Average DJIA, meanwhile, has fallen 0.5% in October and was down 225 points, or 0.5%, at 42,125 in recent trading, LSEG data showed.

Stocks are said to be in a bull market when an individual stock or index has risen 20% or more from a recent notable low. Conversely, bear markets are defined as a drop of 20% or more from a recent high.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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10-07-24 1425ET

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