The stock market rally is in its 8th year and with the election of Donald Trump markets added yet another phase to the rally. Does this mean that the next bear market is now more imminent than before?
Last year we had a fascinating turn in market sentiment around about the middle of the year when investors decided that the bets they were taking on deflation had gone too far and decided instead to bet on a steady reflation of assets. This was largely initially driven by China that started stimulating its economy last year. This reflation trade means that you start to see bond yields go up and bond prices fall, you see stocks begin to recover. When Donald Trump was elected in an event that many people thought would be bad for the markets, you saw a real shot of adrenaline for that reflation trade. Stocks went up more, bond yields rose and there was a plain additional confidence that the US will contribute to global reflation, picking up the baton from China.
One thing that Donald Trump has achieved is boosting the financial market quite dramatically. Before his election in November there were a lot predictions that the markets would crash. In fact, the reverse has happened. That reflects a lot of investors excitement about the promises president Trump has been making about deregulation, tax cuts, infrastructure spending and repatriation of overseas cash piles. Many investors, it seems, have been certainly applauding Donald Trump quite loudly.
Another area where Donald Trump has had some success is consumer confidence. Consumer confidence has been low in recent years which is not a coincidence following the aftermath of the financial crisis, the long recession and the fact that wages have not been going up in the US. Consumer confidence has hit a 17-year high which is quite remarkable.
Unfortunately, there is one problem in the US economy. If you look at the hard data, i.e. the tangible statistics on what happened in the economy have not been encouraging at all. Auto sales, retail sales, corporate investments, industrial production all these numbers have been flatlining. The US economy grew only 0.5% in the first 3 months of the year which is lower than last year and a lot lower than the 4% economic growth Donald Trump promised on the campaign trail. If you are optimistic, you may argue that we have to give Donald Trump´s initiatives enough time to deliver the anticipated results.
Still markets appear quite resilient and may not be that dependent on political decisions as initially anticipated.
If you look at the progress of the stock market in President Trump’s in office, plainly, the worst moment came when his first attempt to health care reform collapsed. This has implication on tax reform that people wanted. Yet the market is learning to tell Mr. Trump’s bark from the bite. While optimism may be dwindling, the belief remains that the president will not harm progress. This realization just took some froth off the market, but we have not had more than that.
The other reason why the stock market has done reasonably well in the past few weeks is that earnings so far this season- which are the single most important measure for stock valuations – have come in better than expected. Many companies that we follow handsomely exceeded analyst expectations and are now trading at record levels. Another reason the market has had a sharp rebound is that there was an important political event in France and the market liked what it heard.
On an aggregate basis valuations of stocks and bonds in the US are expensive. You can argue that stocks are not that expensive compared to bonds and that is a reasonable case to make but all it tells you is that you are desperate for bond yields to stay roughly where they are and you are admitting that this is all that keeps stocks high. If you look at individual stocks, however, valuations are driven by gains in efficiency, higher revenues and profits and therefore can justify higher valuations. Still, investors are now increasingly looking at European companies as the next leg for the reflation trade.
The rally of the past eight years is not unprecedented. There have been longer rallies in the stock market. Markets have proven to be more resilient this time around than anticipated and less linked to politics than feared. Interestingly, markets are currently focusing on fundamentals which makes them more resistant to political uncertainties although markets will never be able to completely disconnect from politics.
What gets dangerous is when you assume we have come too far, too fast, and think that the rally of the last eight years means we are due for crash. We will have more bear markets. Maybe starting next month, maybe next year, maybe five years from now. The fact that we are surprised at how far we have come since 2009 should be a reminder that outcomes are surprising, not that your prediction of a new bear market is due to come true.
The most important thing any of us can do is contextualize big rallies and big drops against two things: our own personal needs and goals, and the long-term record markets have produced over time:
Remember that you are an investor in companies and are investing for the long-term. If history since 1871 is any indication of future returns, you should feel confident. If you have questions on how to match your goals and needs, please drop us a line.
Zurich, May 3rd, 2017