Bull Markets Are Approaching Their Second Birthdays. Here’s Why It Will Likely Continue

The U.S. stock market's current bull run is approaching its second anniversary, marking another key milestone in a rally that has far exceeded the expectations of even the most optimistic investors on Wall Street.

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Since October 12, 2022, the S&P 500 has surged over 60%, recovering from its bear-market low of 3,577.03, according to FactSet data. This impressive gain unfolded much faster than anticipated, leading Wall Street firms to continually revise their year-end targets higher to match the market’s performance.

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Goldman Sachs, for instance, has adjusted its S&P 500 target multiple times this year to reflect the unexpectedly rapid growth in stock prices. Despite the sharp upward trajectory, the bull market shows little sign of slowing down, although market volatility has increased over the past three months.

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The Cboe Volatility Index (VIX), widely referred to as the market’s “fear gauge,” spiked to its highest intraday level since March 2020 during a global market selloff on August 5. However, this increase in market anxiety quickly subsided as stocks rebounded. A similar downturn occurred in early September, but once again, investors stepped in to buy stocks at discounted prices, causing the market to recover.

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As a result, the S&P 500 has now delivered its strongest performance during the first three quarters of a year since the late 1990s. Should the index maintain its current pace through the end of December, it would mark two consecutive years of gains of 20% or more, a feat that hasn't been achieved since 1998, according to data from Dow Jones Market Data.

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Despite this momentum, potential risks to the rally have grown in recent months. U.S. stocks are trading at valuations that are high relative to historical averages, nearing levels last seen in late 2021. At the same time, geopolitical tensions have resurfaced, particularly with renewed conflict between Israel and Iran, which has driven up crude oil prices and increased uncertainty among investors.

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In addition, as the third-quarter earnings season kicks off, investors will be paying close attention to reports from major tech companies like Microsoft, Alphabet, and Nvidia. These companies, which are considered leaders in artificial intelligence (AI), are expected to provide clues about when their massive investments in AI technology will begin to generate substantial returns. Nvidia's last earnings report in August, while strong, did not deliver the market boost that investors had hoped for, leaving many cautious about the upcoming results.

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Furthermore, the looming U.S. election on November 5 has prompted many traders to hedge their portfolios against potential volatility. The outcome of the election could be uncertain, and a contested result might lead to heightened market turbulence, adding another layer of risk to an already unpredictable market environment.

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Amid these concerns, investors are looking for guidance on the future direction of the market. Analysts at Ned Davis Research have examined how previous bull markets have fared after reaching their second anniversary. Their findings show that since the end of World War II, there have been 12 bull markets that lasted at least two years. The current bull run would be the 13th, barring a significant selloff before the end of this week.

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Of these 12 bull markets, seven continued into their third year, suggesting that the odds favor the continuation of the current rally. The median two-year gain for these bull markets was 54.4%, meaning that the current market's 60% advance is not extraordinary compared to historical precedents.

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However, the outlook becomes less clear beyond the two-year mark. Bull markets that reached their third year saw a median gain of 13.3%, while those that faltered experienced a median decline of 5.9%. Importantly, none of the bull markets analyzed by Ned Davis Research ended simply due to age. Instead, they were typically derailed by external factors, with recessions being the most common cause of market downturns in the third year.

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In three cases, recessions triggered the end of the bull market, while in a fourth instance, the Federal Reserve’s decision to tighten monetary policy to combat inflation ended the rally that began in October 1966. The fifth example, which started in March 2009, was cut short by a combination of Standard & Poor’s downgrade of the U.S. credit rating and concerns over the European sovereign-debt crisis.

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For the current bull run to continue, three key conditions must be met, according to Ned Davis Research. First, the disinflationary trend that began in late 2022 must persist. Recent concerns about a potential resurgence of inflation have emerged since the Federal Reserve made a significant interest-rate cut. If inflation accelerates again, it could trigger a market selloff.

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Second, the Federal Reserve must manage to engineer a soft landing for the U.S. economy. This involves achieving slower but still positive economic growth while reducing inflation back to the Fed’s 2% target. A recession would likely lead to a decline in stock prices, but the Ned Davis team believes the chances of this happening are relatively low at the moment.

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Finally, the largest U.S. companies need to continue delivering earnings growth. While Wall Street expects a slowdown in earnings growth for the so-called “Magnificent Seven” mega-cap companies benefiting from AI, other companies in the S&P 500 are expected to pick up the slack. However, these forecasts are subject to change based on economic conditions.

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As of early October, U.S. stocks have gotten off to a weak start. The S&P 500 is down 0.6% for the month, while the Nasdaq Composite and Dow Jones Industrial Average have also posted declines. Nevertheless, the market remains in a bull phase, having risen more than 20% from its most recent low, despite recent volatility.

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