Donald Trump’s cryptic remarks last week about “the calm before the storm” “could have been a sage assessment of the world’s stock and bond markets”, says Randall Forsyth in Barron’s. They look ominously relaxed. The CBOE Volatility index, or “fear gauge”, which tracks the extent to which investors try to hedge against market turbulence, hit a 24-year low last week as Wall Street kept marching to new all-time highs. By late last week the S&P 500 had closed at a new record for eight days on the trot – the first time this has happened since 1997, in the middle of the dotcom market surge.
Most stockmarkets are far from cheap after an eight-year run-up. Indeed, in the US the cyclically adjusted price/earnings (p/e) ratio has only been higher than today’s level of 31 on two occasions: just before the 1929 market crash and during the dotcom mania. As for bonds, “rarely have creditors demanded so little insurance against default”, says The Economist. Government bonds are so absurdly expensive that in many cases yields have turned negative (they move inversely to prices).
Investors have hoovered up Iraqi and Egyptian debt in recent weeks. Yields on traditionally risky junk bonds are at multi-year lows. Property markets in much of the developed world are at record highs too. “The world is in the throes of a bull market in everything.”
Still, while high valuations certainly imply poor long-term returns from here, they don’t point to an imminent crash. And it’s hard to see an immediate trigger for a major market upset in any case. Stocks have become increasingly resilient to political upsets. S&P 500 earnings have rebounded strongly from a nasty downturn in 2015-2016 (see page 7), and as a result the equity market is not as untethered from its fundamentals as it was two years ago. There are also few signs so far of the euphoria that usually accompanies the final stage of a long bull market.
US profits bounce back
The US market is seeing “great” profit growth, says Nicole Bullock in the Financial Times. Having fallen for five successive quarters in 2015-2016, profits have recovered strongly this year. In the first and second quarters of 2017, S&P 500 year-on-year earnings growth reached 14% and 10% respectively. And while the third quarter is not expected to be as strong – analysts have pencilled in annual earnings growth of 3.2% – this is expected to be a temporary, hurricane-induced dip.
One cause is the increasingly solid, albeit unspectacular, recovery. Sales growth estimates for the third quarter look robust. Ongoing cost-cutting is also playing a part, as is the rebound in oil prices, which is bolstering the energy sector. A key reason, however, is this year’s US dollar weakness.
US large caps make around half their sales abroad. Morgan Stanley calculates that an 8% slide in the dollar index throughout a year equates to a 4% improvement in annual earnings growth, says Bloomberg’s Elena Popina. How long this tailwind will last is unclear, but for now, steep market valuations look partly justified by robust profit growth.
Most importantly, however, all markets profit from liquidity, and in this respect “they have been doped to the point of delirium”, says Jeremy Warner in The Sunday Telegraph. There has been so much quantitative easing, or money printing, in recent years that the Bank of Japan has spent magic money worth 100% of GDP on bonds and other assets; the Bank of England, 20%.
The US is finally starting to raise interest rates, but on a global scale central banks’ balance sheets are still expanding at an annual pace of 8%, Renaissance Macro Research’s Jeffrey deGraaf told Randall Forsyth. “This rowdy party”, concludes Forsyth, is not over yet.