The ‘Trump trade’ is fizzling out – but here’s why it is not time to prepare for the bear
One of the oldest rules in the book investors are urged to follow is to ‘buy high’ and ‘sell low’ – but when it comes to the US stock market, all logic appears to have gone out of the window.
As Money Observer has previously pointed out, on all of the main conventional valuation measures the US stock market has an expensive price tag. In particular on the Shiller p/e ratio, a measure that compares a firm’s market value with its profits over 10 years, the S&P 500 has a score of 28 versus a historical mean of around 17.
Rich valuations, however, do not necessarily indicate the market is ripe for a fall. Stock markets can stay overvalued for years and become even more expensive.
In fact, according to new research by JP Morgan Asset Management, which looks at common characteristics of the 10 biggest bear markets since the Wall Street crash in 1929, extreme valuations do not singlehandedly tend to cause a market meltdown (although there were two exceptions to that rule – the 1987 programme trade crash and the ‘flash crash’ of 1962).
On the other eight occasions, as the chart below shows, a recession was the final straw that tipped stock markets over the edge.
Click on the chart below for an expanded view:
Mike Bell, global market strategist at JP Morgan Asset Management, points out that there is ‘scant signs of a recession on the horizon’. He says investors therefore should not be overly concerned about the ‘ageing’ Trump rally.
‘Shares have continued to ratchet higher in what is an ageing bull market, and chances are they could keep on rising, but some investors fear that the age of this recovery is increasing the probability of a bear market in the near term. Admittedly valuations are looking reasonably high, particularly in US equities, where stocks are currently priced above their long-term historical average,’ says Bell.
‘However, investors need to remember that bull markets don’t usually die from old age, nor do they die from high valuations alone. Almost always the culprit is economic recession and today there are scant signs of recession on the horizon.’
According to Bell the US economy looks healthy, with corporate profits, business investment and employment growth all ‘chugging along’ nicely. Moreover, Trump's pledged tax cuts and spending sprees are other plus points for the economy, providing they see the light of day.
But as Wesley Sparks, head of US credit strategies at Schroders and manager of the Schroder ISF Global High Yield fund, has previously pointed out, spending plans come hand in hand with a growing government deficit.
Speaking to Money Observer at the end of last year, Sparks said: 'There are reasons to be bearish, but ultimately the cause of a bear market or a recession is usually triggered by interest rates going up too aggressively or the housing market declining.'
For the time being at least, according to Bell, ‘there is nothing yet to suggest the current market rally will be derailed by recession risk’.
But putting the US economy to one side, there are other threats on the horizon that financial markets have not priced in, which could derail the bull market.
The biggest unknown is how financial markets will react when the money-printing stops. Those investors in the bearish camp are concerned that the bull market enjoyed by both US and UK equities since the financial crisis has been propped up and inflated by quantitative easing, rather than rising sustainably on fundamentals such as profit growth.
Therefore, when QE is removed, those in the bearish camp expect a stock market correction to play out. But other sceptics argue there is no proof that QE has helped stimulate the economy.