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Now would be a good time for investors to curb their enthusiasm, just a little. This year began with the bulls largely in control. Indeed, US stocks rose about 4 percent, making this month one of the strongest opening months of any year in the past decade.
The re-inauguration of Donald Trump as President of the United States ushers in a new era of “Animal spirits“Among business executives, veteran investor Stan Druckenmiller said this week. He told CNBC that CEOs are “somewhere between relieved and giddy” with the election result. Meanwhile, U.S. banks are in “Go mode“, as cryptocurrencies are about to enter,” a senior JP Morgan executive told the Davos crowd.Banana area“, according to its boosters. (No, neither do I. This seems to be a good thing, although it indicates that prices are about to rise.)
HSBC is sticking to the good vibes. Its multi-asset team this week set out a “very positive” backdrop for risk assets in the first half of this year – a scenario it described as “moderate on steroids”, just the picture.
At the risk of spoiling all the fun, some market watchers – including some optimists – are getting a little nervous. The first big reason is the global government bond market, which has gotten off to a shaky start to the year. This is not entirely a bad thing, as it reflects the continuing miracle of economic growth in the United States. But it also reflects an expectation that inflation will persist, so the Fed will struggle to keep cutting interest rates — no matter how much Trump wants to. On the sidelines, it also points out that asset managers are demanding a somewhat higher rate of return to replenish government coffers.
Whatever narrative you prefer here, the point is that bond investors got it wrong (again), and that the resulting fall in prices drove up yields (again). The most important benchmark of them all – the US 10-year bond yield – sits well above 4.5 per cent. This represents a rebound in prices since mid-January, but is still high enough to undermine the case for increasing inventories.
As my colleagues I reported this weekUS stocks have now reached their highest cost point relative to bonds in a generation. It is more difficult than ever to justify venturing further into a stock when its expected earnings relative to year-to-date earnings have fallen below the risk-free rate.
Peter Oppenheimer, chief global equity strategist at Goldman Sachs, noted at an event in the bank's lavish London office this week that stocks have largely ignored this competition from bonds so far — largely because optimism about growth is so strong. . But this now leaves stocks “vulnerable to further rises in yields.”
It's somewhat silly, but it is nonetheless true that a lot here is based on rough numbers, which serve as useful psychological signals for investors. The big test will be if US bond yields reach 5 percent. At that point, one of two things could happen: Either bond haters will give in and take some trades to drag yields down again, or the selling will intensify and every asset class will feel the pain. My strong intuition is first.
We're not there yet, but as Lisa Shalit, chief investment officer at Morgan Stanley Wealth Management, said this week: “We're still at a critical level.”
“We are really approaching the zip code where a little slower growth and a little higher rates become a deadly combination for markets,” she said. As a result, she is skeptical that stocks in general, and highly concentrated and highly technology-driven US stock markets in particular, can continue on the amazing trajectory of the past two years. Shalit expects gains in US stocks ranging between 5 and 10 percent this year. This is not bad by any means, but it will not be a repeat of the performance that exceeded 20 percent in each of the past two years.
Another factor ringing alarm bells is the level of optimism itself, especially among retail investors. The American Association of Individual Investors reported that sentiment has “roseIn its latest monthly poll, the institute said that expectations of rising stock prices over the next six months jumped by about 18 percentage points through January.
Even the optimistic wealth managers who advise many of these investors are having trouble keeping their nerve. Ross Mayfield, an investment strategist at Baird Private Wealth Management, told me this week that he believes in a bull market, albeit with little interest in bond yields, which have moved “up and to the right for no apparent reason.” But he sees anecdotal evidence that the theme of American exceptionalism has become overly entrenched among his clients. “I started getting questions about whether I needed to diversify at all,” he said.
None of this is a reason to run for the hills and hunker down in the safest asset you can find. But the atmosphere has become somewhat weak at these heights, and the possibility of missteps on the part of the new US presidential administration is strong. Glassy-eyed optimism rarely ends well, no matter how strong the moderate.
katie.martin@ft.com
