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Amid all the talk of a bear market in US Treasury bonds as the benchmark 10-year yield settles above the 3 per cent mark for the first time in four years, America’s previously buoyant stock market is emerging as the main source of anxiety.
In the bond market, the reasons for the sharp rise in yields, particularly at the shorter end of the curve, are crystal clear. Inflation in the United States has reached the Federal Reserve’s 2 per cent target, increasing the central bank’s confidence in pushing ahead with further rises in interest rates and fuelling speculation about a sharper tightening in monetary policy. The two-year Treasury yield, which is most sensitive to the Fed’s expectations, has doubled since last September.
In the equity market, however, the poor performance of the benchmark S&P 500 index since January 26, when it reached its last of a series of record highs, is much more difficult to explain, particularly given the recent string of positive corporate news which ought to be lifting share prices.
US companies have just enjoyed the strongest growth in quarterly earnings since the third quarter of 2010. According to Bloomberg, more than 80 per cent of the 265 members of the S&P 500 beat analysts’ forecasts for the first quarter of this year.
Last week, Apple, the world’s most valuable company, launched a massive US$100 billion share buy-back plan and raised its dividend by 16 per cent – the largest increase yet in its capital returns to shareholders – as it reported an upbeat outlook for its iPhone sales despite concerns of a slowdown.
Another reason stock markets should be rallying is the fierce pace of global merger and acquisition activity, underpinned by solid economic growth, the continued availability of cheap debt to fund takeovers and last year’s sweeping US tax reform package. According to Dealogic, a data provider, global deal-making since the start of this year has surged to a whopping US$1.7 trillion, exceeding the highest levels before the global financial crisis.
Yet despite the strong profit gains in the first quarter, the S&P 500 has languished since early February.
Last Thursday, the index tumbled below its 200-day moving average, a key technical level, for the fourth time in the last month. Having just suffered its first negative quarter since the third quarter of 2015, the S&P 500 has barely budged since early April and is still down more than 7 per cent from its peak in late January.
The poor performance of the world’s leading equity gauge has had a dampening effect on broader sentiment. Global stocks, as measured by the MSCI All Country World Index, are down 7.5 per cent since late January, with German, Japanese and emerging market shares falling 5.5 per cent, 7 per cent and nearly 11 per cent respectively.
Equity investors have stopped “buying the dip”, the trading strategy that epitomised the decade-long bull market whereby investors loaded up on stocks in downturns, in expectation of a swift rebound.
While the reasons for the bearish tone in equities are unclear, and keep changing nearly every week, a number of key factors are at play.
The most important one is a growing sense among investors that equity markets have peaked. According to last month’s global fund manager survey by Bank of America Merrill Lynch, nearly a fifth of respondents believe stock markets have already topped out, while 40 per cent believe the peak will be reached in the second half of this year. What is more, the percentage of fund managers who believe corporate profits will improve over the next year has plunged to its lowest level in 18 months.
Make no mistake, the watchword in markets now is “late cycle”.
A second, equally important, factor is the negative influence exerted by market developments in the US. Having previously driven the rally in global equities due to the remarkably subdued volatility in stocks and the dramatic increase in the shares of technology companies, the US is now “exporting” turbulence – both in equity and bond markets. Woes of tech firms, centred around Facebook, the Fed-induced rise in bond yields and the dollar and, crucially, President Donald Trump’s protectionist trade policies are all undermining sentiment across the globe.
The good news is that there are still no signs of capitulation in stock markets. On the contrary, fund managers remain bullish on tech companies and emerging markets.
The bad news is that the bullishness is not helping share prices one bit.
It is not surprising, then, that last month’s BAML survey is titled “The Silence of the Bulls.”
Nicholas Spiro is a partner at Lauressa Advisory