It won’t have escaped anyone’s notice that the US equity markets have been in an astonishing bull run which has outpaced expectations for many, and some. Based on the availability of cheap money, the heavy composition of buy-backs has accentuated the move on Wall Street to levels where valuations are not only high but largely seen as overstretched when taking into account the pace of growth in the real economy.
However, in recent week’s and months, we have seen jitters in the major US indices, more notably in tech stocks, when US long end rates have neared key levels. The 10yr Note has tipped the 3.25% mark while the 30yr got tantalisingly close to 3.50% and the sell-off (in stocks) was not pretty.
This has prompted some to suggest the Fed may rein in their aggressive tightening path, which is in direct response to an economy close to, if not at full employment, while inflation is also picking up, based on the data received by official sources. Some are sceptical that inflation is as strong as is reported, but going off core PCE, there is pick at least – something the Fed were patiently waiting on through 2017 under chair Yellen’s leadership. Now we have it, Powell and Co are applying the brakes, with a terminal rate of 3.50% suggested by the dot plot.
However, the ECB and BoJ remain in an accommodative mode and come the end of December, the former will have ended their asset-buying program, though the focus is on Japan, where central bank and institutional buying of US assets continues. Whether this will do so after another jolt to the downside (on Wall Street) remains to be seen, but there is still cheap money out there and it continues to support equities.
While the BoJ suppresses JGB yields on the 10yr to 20bps, it is hard to see how this QQE can filter back into the economy and reflate prices, though there are structural issues which point to anaemic consumption, while savings – which exacerbate divestment for yield – continue to bolster assets with higher returns.
Next year will be the more interesting for global equities, which have shaken off a range of risks including trade wars, systemic risks from Brexit as well as an EU slowdown (hampered by populism). However, there is also the combined effect of a potential slowdown in the US, with the effect of the tax cuts working through the current cycle, a well as a higher rate environment. Japan will also have a higher debt to GDP ratio which is already in excess of 250%, and it is hard to see how they will be justified in maintaining this path if inflation has not materially worked through. There surely has to be an endpoint at which one has to say this is not working. What then for stocks