With the US market now in the longest expansion on record, what’s behind its new lease of life?
The S&P 500, the main market index across the pond, hit a new record high on Thursday (21 June), closing at just over 2,954.
While the US market previously closed at a record high in early May, throughout the rest of the month investor sentiment slumped on fears over the escalation of the trade war with China and US president Donald Trump threatening to place tariffs on Mexico, among other things.
Since then, though, the US market has started to edge up, reaching its most recent new high. With the US market already trading on historically high valuations and the stockmarket now in the longest expansion on record, what’s behind its new lease of life?
1) Don’t fight the Fed
The first and most simple answer is the Federal Reserve. As was widely expected, the Fed’s latest policy announcement was “dovish,” meaning the bank signalled its intention to create looser monetary conditions.
While the Fed did not cut interest rates, as many investors had hoped, the bank kept its rates unchanged at 2.25 - 2.50 and communicated that it would likely cut rates at some point in the year. The market now expects between one or two rate cuts.
Low interest rates and loose monetary policy is supportive of shares, whose valuations appear more reasonable next to low interest rates and low yielding bonds. This has been one of the major reasons for the strong performance of the US market over the past decade.
How long the Fed can maintain this and keep markets happy remains to be seen. The Fed’s attempt to raise rates to historically more normal levels at the end of 2018 saw US markets slip by almost 20%. For now, however, the music is still playing so markets are still dancing.
2) Herd mentality
Over the course of May and June certain risks receded: Trump’s threat of escalating his global trade war with Europe and Japan fell off the news agenda (for now at least), while the implementation of new tariffs on Mexico never came to fruition.
With those risks receding, the market started to pick up, gradually building momentum with more investors piling in, fearing they would miss out on the latest rally. As Michael Batnick, director of research at Ritholtz Wealth Management notes: “All-time highs are a breeding ground for regret. This particular all-time high, like many before it, came from a sharp reversal.”
3) Where else is there?
At the same time, while equity valuations may appear to be stretching the limit, the US economy is showing performance that other developed markets could only dream of.
Since Trump’s election, the US economy has grown by 7% in real terms – a solid achievement for an advanced economy. Other developed market economies have been way behind, with the eurozone and Japan each growing by about 3.4% over that period of time, half of what the US has achieved.
That outperformance is set to continue. The OECD’s latest forecast is that the US economy will grow by 2.8% this year while the eurozone will grow by just 1.2%. Meanwhile Japan will continue to see snail pace growth at 0.7%.
US economic performance outpacing the rest of the world has been a major propeller for the rally in US equities over the past few years. If the US economy is expected to continue outperforming the rest of the world, is it any wonder that investors are piling in?
Risks are out there
Other investors may view this as short-sighted. First of all, if the US economy is on such a strong footing, it raises the question of why the Fed should now be so dovish? Indeed, if the US economy really is so strong surely it should be able to stomach rates above 2.5%.
Instead, the market is expecting stimulus. Investing in US equities because the US economy is strong while also investing in US equities because the Fed is starting to ease monetary policy appears somewhat paradoxical.
Second, the US economy still faces significant risks. Luca Paolini, chief strategist at Pictet Asset Management, thinks that US investors are too lackadaisical when it comes to the trade war. He argues: “we think that investors have long been complacent about the trade war’s potential impact on technology stocks.
“Huawei’s blacklisting by the US administration raises the spectre of a new technological cold war and underscores how vulnerable companies in the sector are to sudden restrictions – all the way along the global supply chain."