Is the Two-Year-Old Bull Market 2 Legit 2 Quit?

In markets, a year can feel like a lifetime. Ditto for two years, which is how old the S&P 500's current bull market now is (as of a couple days ago). While that calls for celebration, it perhaps begs for a deeper analysis into the unique nature of this run, what sets it apart from prior bull markets, and the outlook for its longevity.

Before getting into the meat of the current bull, it's instructive to look into its origins. At risk of stating the obvious, every bull market is born out of the end of a bear market. Below we've detailed 14 of the S&P 500's bears (using the standard -20% definition) in the post-WWII era. Bear markets that occurred in conjunction with a U.S. recession are highlighted in red. That has more often been the case, making the most recent downturn the first non-recession bear market since the late 1980s.

It's not always the case that recessionary bears have worse drawdowns, but they have historically lasted longer. They also tended to breed longer lifespans for the subsequent bull run. Our friends at The Leuthold Group found that the average life of a bull market following a recession is nearly twice as long (61 months) as one that doesn't follow a recession (33 months).

Perhaps unsurprisingly, that has historically tended to mean stronger gains for post-recessionary bull markets. As shown in the table below, the current bull has logged a return of 62.7% in the first two years of its life. That is right in line with the average first two-year gain following a recession (62.9%) but stronger than the average following no recession (40.5%). Looking at gains after the first three years is where the more important distinction is, though. The average return for the S&P 500 bull's first three years following no recession is 41.9%, not that much stronger than the average in the first two years. Yet, following a recession, the average return for the first three years is much stronger at 66.8%.

One thing nearly all bulls have had in common in their first three years has been at least a double-digit percentage drop at some point. In fact, there was only one bull market with a single-digit maximum drawdown in its first three years: the one that started in 1990.

It's intuitive that gains last longer and are stronger following a recession, since downturns tend to cause washouts in both the economy and stock market, allowing for sharp recoveries. That is evident via the market's valuation, which usually gets reset lower after a recession. Looking at the far-right column above, the average S&P 500 five-year normalized price-to-earnings ratio (P/E)—which uses four-and-a-half years of trailing earnings and two quarters of estimated earnings for the E, and takes the midpoint between reported and operating earnings— was 16.5 at the start of bull markets that didn't follow recessions versus 14 for bulls that started after recessions.

What's interesting and unique about this current bull is that, based on the five-year normalized P/E, it was the most expensive in history when it began. Earnings have indeed recovered nicely over the past couple years, but the fact that multiples have grown faster means there might not be as much juice left to squeeze out from multiple expansion. That puts the onus increasingly on earnings.

Keeping on the theme of the unique nature of this bull market, one aspect that stands out is how low the unemployment rate was at its beginning. As shown in the table below, the current bull started with the unemployment rate at 3.6%—the lowest in the history of new bull markets. That is just a hair lower than the prior record low of 3.7% in 1966. Interestingly, that bull market was short-lived and only lasted for about two years. We don't believe it's a perfect analogy, but it speaks to the staying power (or lack thereof) when the economy fails to go through a full washout.

One aspect in which we had been waiting to see improvement, and now finally have, was the breadth of gains across sectors. As shown in the table below, in the first year of this bull market, participation was unimpressive and concentrated in two sectors: Information Technology and Communication Services. Even more concerning was the fact that two sectors (Consumer Staples and Utilities) were down in the first year, which has never happened.

While that underscores the relatively unhealthy nature of this bull market's early days, we think it speaks more to the fact that investors have at times opted to look for shelter in non-traditionally defensive sectors throughout this cycle. That has looked less extreme in the past year, though, since you can see (via the far-right column) that more sectors have joined the party. One of the most notable and impressive jumps has been for Financials, which is trailing only Tech over the past year.

The last point to make on just how different this bull is relative to history is by looking at small caps. Over the past two years, the Russell 2000 has done well in absolute terms, as it's up by more than 25%. However, that is by far the weakest bull market start in the index's history, as shown in the chart below. We would again chalk this up to the fact that there wasn't a recession in 2022—in addition to smaller firms still struggling under the weight of high interest rates and a sluggish profit recovery.

While much excitement for a rotation into small caps has stemmed from the Federal Reserve's pivot to rate cuts, we aren't as convinced of a broad-based leadership shift down the cap spectrum as long as economic growth and the labor market don't materially accelerate from here. To be sure, there has been a broadening out in participation, but more so in the profitable segments of the Russell 2000. We have more conviction in that trend, but it will be difficult for index-level gains to reflect that strength since about 40% of members in the Russell 2000 are not profitable.

Wrapping this up with a point on the Fed, an important reminder is that every bull market, bear market, expansion, and recession is different. The same goes for Fed cycles, which is why we're always quick to urge caution when using any one cycle as a guide.

In the history of Fed cutting cycles, there have only been two that started with a 50-basis-point (bps) cut and were not followed by a recession in the following year: the 1967 and 1984 cycles. As shown in the chart below, the S&P 500 struggled in the year following the 1967 cut, presumably because the first cut was actually the only cut—and perhaps because inflation reignited not long after. In the case of 1984, the market did quite well after the first cut, but it also underwent a significant correction leading up to the start of the cutting cycle. That is the opposite of what happened in the most recent pause period (from July 2023 to September 2024), as the S&P had its best gain ever leading up to the start of a cutting cycle.

That reinforces the fact that we are in unfamiliar and unique territory when it comes to this cutting cycle—which isn't necessarily a bad thing. For now, the Fed is cutting rates to dial back restrictiveness in the economy, not because the economic bottom is falling out all at once.

So much can be (and has been) said about the unique nature of this bull market and economic expansion. The ripple effects of the pandemic are still lingering and among the many reasons this cycle is not easily compared to others. History is consistent, however, with the notion that bull markets don't tend to die of old age; they're usually eliminated by something—not easy to anticipate in advance. For now, we find comfort in the fact that nearly 80% of S&P 500 members are trading above their 200-day moving average, sector participation has increased markedly over the past year, and monetary conditions are more favorable for stocks. That isn't to say year three of the bull's life will be without volatility. With valuations looking quite stretched and investor sentiment (specifically behavioral measures) on the frothier end of the spectrum, the market may be a bit more vulnerable to pullbacks in the face of any negative catalysts.