New year's global stock market 'melt-up' silences bears – Financial Times

On Wall Street the first week of 2018 has been marked by talk of a “melt-up”, “rational exuberance” and renowned hedge fund manager David Tepper asking anyone to “explain to me where this market is rich?”

The giddy mood has both fed, and been vindicated by, the performance of the US stock market’s leading indices, which have set fresh highs and not skipped a beat from where they finished last year.

The success late last month of Republicans in Congress and Donald Trump in delivering tax cuts has hardened the conviction of some that the second-longest bull market in US history has further to run. At the same time, the first snapshots of manufacturing in the US, the eurozone and China point to a sustained upswing in global growth — one of the anchors of last year’s rally.

If the start of 2018 has seen the mood warm to a bull run that has not always been loved, there remains concern that the focus could ultimately switch to the plans by the Federal Reserve and the European Central Bank to dial back their stimulus plans.

David Donabedian, chief investment officer of CIBC Atlantic Trust, believes 2018 will unfold in two phases.

“January and February are likely to be quite strong with a good economy, good earnings growth and tax reform, but as 2018 wears on there could be some problems,” he said. “After tax reform, there could be a ‘what’s next?’ kind of sentiment, especially in terms of valuation.”

The excitement over the effect of tax cuts on earnings could, later in the year, give way to concern around the US midterm elections, which could loosen the Republican grip on Congress.

For now, though, many investors are unfazed. Jeremy Grantham, the co-founder of asset manager GMO and a normally bearish investor, noted that: “I also recognise that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market.“

Alongside the still benign global economic backdrop, the cut in the corporate tax rate from 35 per cent to 21 per cent has helped propel expectations for corporate profits higher. According to FactSet, consensus estimates for earnings per share growth for S&P 500 companies are almost 13 per cent, against expectations of 9.5 per cent last year.

Some, such as Phil Orlando, chief equity market strategist and head of client portfolio management at Federated Investors, have already pushed their forecasts for the year higher. Federated added $10 to its 2018 and 2019 EPS estimates for the S&P 500 to $150 and $160 respectively

“3000 was our [S&P 500] forecast for 2019,” he said. “Now it is our year-end [2018] target.”

While Mr Orlando has lifted his forecasts, the tax cuts are seen as only partly factored into prices — and earnings expectations — as strategists continue to work out what the fine print of the tax bill means. Investors and sector analysts are eagerly awaiting guidance from companies as earnings season for the fourth quarter heats up next week.

“There are a lot of fundamental reasons to still like the asset class,” said Kate Moore, BlackRock’s chief equity strategist.

Even if they have not been heard amid the early year euphoria, those with concerns over valuations are not likely to finish the week feeling any more comfortable. Besides the basic forward price to earnings multiple being above long-term averages, two widely watched metrics are also signalling at least yellow if not outright red.

On a price to sales basis, the S&P 500 is nearing peaks reached back in the dotcom bubble, while the cyclically adjusted price-to-earnings ratio kept by Yale economics professor Robert Shiller is at levels topped only by the heights hit before the dotcom bubble burst in 2000 and the Great Crash of 1929.

This bull run has been dubbed “the most hated” because of the role of central banks in fuelling it through the vast stimulus plans introduced since 2009. For Nicholas Colas, cofounder of DataTrek, the big risk is that as the Fed unwinds its balance sheet and the ECB offers less monetary stimulus, the massive amount of liquidity sloshing around the world begins to fall, interest rates rise faster than expected and valuations collapse.

“Equities, fixed income, negative rates in Europe and Japan, real estate, particularly in China and the icing on the cake is the whole cryptocurrency craze — it is what happens when rates stay low too long,” he said. “People flood the system with whatever provides any return. Everything feels like a top and no one has a solid handle on what will make this pop.”

While Jay Powell, who becomes chair of the Federal Reserve next month, is not expected to speed up the pace of rate rises, he has shown a notable interest in the risks around both asset prices and the structure of markets.

“My big concern really comes midyear and beyond. The gains we have seen across asset markets globally are pretty easily explained by QE,” said Lee Ferridge, head of macro strategy at State Street. “The market seems bulletproof but, when liquidity starts to dry up, it will be interesting to see whether gains can be continued.”