Why the next bull market is unlikely to look like the previous one

Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our newsletter sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know.

What the next bull market might look like is probably the last question on investors’ minds with interest rates rising, inflation soaring and a recession looming.

Yet, with equities skirting bear market territory, advisors can make a good argument that stocks present a buying opportunity, with prices down significantly from all-time highs, to position portfolios for growth when the next bull market begins.

Of course, putting money to work in equities with markets roiling can be a tall order psychologically for clients – especially when the stocks that were winners in the previous bull market may not be the ones to drive growth when the next one arrives.

“It’s interesting,” says Myles Zyblock, chief investment strategist at Dynamic Funds in Toronto. “You go to Walmart Inc., something is 20 per cent off and it seems like a deal, but it doesn’t seem that way with investing when it probably should.”

Of course, investors have good reason to be wary, as inflation remains high with more interest rate hikes potentially to come, although the expectation is Canada, and the U.S. are near the end of the monetary tightening cycle.

A recent report from Deloitte Canada predicts hikes will end by spring as inflation decreases more substantially.

“We’re going to see economic headwinds for the next six to nine months,” says Trevin Stratton, national economic advisory leader and partner at Deloitte Canada in Ottawa.

“And we’re expecting a recession – albeit relatively mild by historical standards.”

The outlook forecasts that by the third quarter, the economy will have decreased about 0.9 per cent followed by modest growth in the fourth quarter. It also predicts the Bank of Canada could even start easing interest rates slightly by year’s end.

Given equity markets generally move in advance of the economy, positioning client portfolios today for the next bull market makes sense.

Certainly, not all investors are reluctant, says Lesley Marks, chief investment officer (CIO) of equities at Mackenzie Investments in Toronto.

“Many are almost impatient,” she says, pointing to recent surges in equity market investment following even slightly positive economic news.

Mostly, recent upswings have been followed by deeper downside volatility, and equity prices could fall more with the upcoming earnings season expected to reflect deteriorating conditions.

“Stock prices are derived from the price investors are willing to pay for future earnings, and in a slowdown, earnings often decline in most cases – a headwind for stock price appreciation,” Ms. Marks says.

Yet, if Deloitte’s outlook proves correct, equities may rebound by the middle of the year as investors anticipate gross domestic product growth.

Why the next bull market will be different

One catch is the next bull market is unlikely to look like the last one.

“All the growth stocks of the past few years are unlikely to head straight up again,” says Paul Moroz, CIO and portfolio manager at Mawer Investment Management Ltd. in Calgary.

Mr. Moroz, much like the other experts interviewed for this article, says he expects growth stocks will not be the ones that propel the next bull market. Instead, it’s likely the next bull market will look like a more conventional one, driven by profitability rather than revenue growth.

“There’s a renormalization likely to happen,” in part because investors are unlikely to see interest rates return to near zero as they did after the Great Recession and the start of the pandemic, Mr. Zyblock says.

“It was like there was zero gravity with nothing holding stock prices down,” he adds about ultra-low interest rates.

Today, gravity has returned with normalized, higher borrowing costs.

Consequently, thematic, high-growth stocks of the previous bull market – i.e. meme stocks like AMC Entertainment Holdings Inc. AMC-N – will likely not fare as well.

“Zombie companies, kept alive by [ultra-low] interest rates that probably shouldn’t have been living, may disappear because they likely don’t have enough net earnings to cover their interest expenses,” he adds.

‘Technology isn’t going away’

Rather, investors are likely to see market growth powered by companies with strong balance sheets, income and cash flow.

“That said, the next bull market won’t be a complete return to value investing,” Mr. Moroz notes. “Technology isn’t going away.”

Many firms still face labour shortages and are looking to technology for solutions, which should benefit tech companies providing those products and services.

“Businesses are not going to go gangbusters investing [in technology],” Mr. Stratton says. “But labour has become so tight that there is an incentive to invest in productivity-enhancing technology.”

Pay attention to oil and gas

Resource companies could also lead – as they already have recently – due to a general lack of investment in production, resulting in a potential “long-term supply deficit for major commodities, energy being one of those,” Ms. Marks adds.

In fact, oil and gas companies’ recent focus on disciplined capital allocation could be the blueprint for success for companies across many sectors, Mr. Moroz says.

“If you’re not being rewarded for growth, you might be for profitability,” he adds. “So, that could lead to companies buying back stock and shedding jobs to boost cash flow.”

Of course, uncertainty reigns, he says, pointing to markets exhibiting characteristics of chaos theory, which was developed by U.S. mathematician Edward Lorenz.

“A butterfly flaps its wings in Japan, and there is a tornado in Texas,” Mr. Moroz says, adding higher interest rates can have many knock-on effects that are difficult to predict.

“People with high-cost mortgages may be pushed to the brink while seniors can get more income from [guaranteed investment certificates]. Yet, others running out of money are going back to work, and that could affect the labour force and inflation.”

The complexity of markets and the economy is such that developing an equity strategy based on the expectation the next bull market could emerge in the fall, for example, involves too much risk, he adds.

Rather a diversified approach, dollar-cost averaging capital into the market for the long-term, provides risk-adjusted exposure to the aforementioned potential outcome and others, Mr. Moroz notes.

The challenge for advisors, though, may be in convincing clients of the opportunity, Mr. Zyblock says.

“When it feels the riskiest, it’s often the safest time to invest for the long-term,” he says. “I’m not saying, ‘Go all in,’ but this is when to add to equity exposure.”

For more from Globe Advisor, visit our homepage.