This week in the markets: investors position themselves for Trump 2.0 nearly two weeks after the Presidential election.
For anyone who was in the markets towards the end of the last great bull market, it feels eerily like 1998 again. Red lights are not yet flashing for investors, and there may well be some exciting months ahead as the Trump Trade fires up - but those who have navigated these waters before are already starting to think about trimming their sails and making sure that everything below decks is stowed away.
Everyone is currently enjoying the Trump Bump, the boost to markets from an expected sugar rush of deregulation and lower taxes. The new President will come into the White House on the back of a buoyant US economy, with good levels of job creation, low unemployment and inflation back under control. The interest rate cycle is turning in his favour too. Providing a fiscal boost against this backdrop could add fuel to the fire.
So, looking for the cloud around the silver lining is a minority sport at the moment. And it may well be too early to turn overly cautious on the markets. But it is far better to think what might go wrong when no-one else is. It’s far easier to position your portfolio for more difficult times when doing so looks unnecessarily pessimistic. When everyone is heading to the exit, it’s easy to get trampled.
The bullish broadening out in equity markets has continued since the election, with both the top 10 and the rest of the S&P 500 hitting new all-time highs. Even the smaller cap Russell 2000 index is within a whisker of its record high, set in 2021. Risk assets like Bitcoin are on fire - the main crypto currency broke above $90,000 last week on hopes for an easier regulatory environment under Trump. And the dollar is back at the top of its three-year range, as expectations of further interest rate cuts are pared back.
The rise in markets has pushed volatility down and valuations up. Investors are happy to accept less compensation for the extra risks of investing in shares compared to bonds - the so-called equity risk premium is historically low. So too is the extra income offered to investors on riskier high yield bonds compared to safe government bonds. At just over 2.5 percentage points this premium is as low as it has been in the past 16 years.
The equity market is being boosted by an unusual combination of rising corporate earnings and rising valuations. Usually, the two move to a different beat with valuations anticipating higher profits and easing back once earnings are actually delivered. When the two rise together, as they did in the mid to late 1990s, the impact on the overall level of the market can be spectacular. The last time this happened was, not coincidentally, in 2017 after the first Trump election win.
This combination does not tend to last, however, and at some point it would be sensible to expect valuations to stop rising and for earnings to have to pick up the baton. This is particularly so because valuations are currently high by historic standards. Using the cyclically adjusted price earnings measure, known as CAPE for short, shares have not been this expensive since the late 1990s. And they didn’t stay at that level for long as the bursting of the dot.com bubble from 2000 on brought valuations back to more sustainable levels.
The good news here is that the earnings side of the equation remains pretty good. The pace of earnings growth revisions may have cooled somewhat but the latest earnings quarter was strong again. Earnings have ended up about 9% ahead of a year ago and the outlook for the next few quarters is for more of the same. That means the market can keep rising even if valuations no longer widen or even start to contract.
One of the winners since the election has been US smaller companies, which are perceived to be a beneficiary of a more protectionist approach. One of the big debates in markets today is whether smaller companies will continue to re-rate higher or will suffer from higher inflation and a possibly slower rate of rate cuts in America. Smaller companies tend to have more floating rate debt and are therefore more susceptible to higher borrowing costs.
Apart from buoyant sentiment and high valuations, another echo of 1998 is the length of the current bull market. Shares have been rising for nearly 16 years since the low point in March 2009 which is how long the bull had been running by the late 1990s. The two big post-war bull markets - in the 1950s and 1960s and then again in the 1980s and 1990s but stretched to 18-20 years. So, this one is starting to feel quite mature.
The buoyancy of the US market is not being felt much beyond America’s shores, which is at the same time a reality check but also reassuring because it suggests that there remains value elsewhere.
Europe, in particular, is lagging badly as investors assess the likely impact of Donald Trump’s proposed tariffs. While US stocks are up nearly 25% this year, European shares are only marginally higher year to date in dollar terms.
At the same time, the euro has slumped to its low point this year of just $1.05 as expectations rise that there might be twice as many eurozone rate cuts on the way as we’ll see from the Fed. Many now expect the euro to reach parity with the dollar as the region finds itself in the front line of Trump’s protectionism.
This week purchasing managers index data on Friday will provide a snapshot of the health of the European economy, with manufacturing expected to remain deep in negative territory. That will drag the composite measure that combines manufacturing and services down to the 50 level at which the economy is neither expanding nor contracting.
It’s a similar story in the UK which delivered a lower-than-expected GDP rise of just 0.1% in the latest quarter and is seeing growth forecasts pared back for the years ahead. Sterling is also sliding against the dollar and was down another 2% last week to $1.26. At the same time, UK stocks are absorbing the recent Budget’s business tax hike.
The focus this week in the UK will be Wednesday’s inflation data, expected to show a meaningful rise in the rate of price rises to 2.2% in October, up from 1.7% in September and above the Bank of England’s 2% target. Energy prices are the main culprit with the cap on household heating bills rising nearly 10% last month.
Perhaps more important is the persistence of inflation in the service sector, which continues at around 5%. Despite cutting interest rates by a quarter percentage point to 4.75% earlier this month, the Bank is clear that it may need to temper the rate of rate cuts if inflation refuses to play ball.
In other markets, gold suffered its worst weekly drop in more than three years last week. Having jumped by more than 35% this year to a new record high, bullion fell 7% this month to around $2,560 as investors weighed up the likely impact of Trump’s policies. Higher for longer interest rates are a negative for gold as it pays no income and so looks relatively less attractive if a decent income is available from other assets. A strong dollar is also bad for the gold price because it makes the metal more expensive for buyers using other currencies.
Gold bulls think that the recent repricing could provide a new opportunity to buy, however, because the geo-political risks that have provided a boost for this safe haven asset have only intensified. In particular, the decision by President Biden to allow Ukraine to use US long range missiles deeper into Russian territory has raised the stakes in that attritional conflict on Europe’s eastern border.
Another big loser in the past week has been vaccine stocks, one of the most visible casualties of Donald Trump’s emerging top team. The appointment of Robert Kennedy Jr as the US’s top health official has raised plenty of eyebrows given his well-known vaccine scepticism before and during Covid. Shaes in Moderna, Pfizer, GSK and Sanofi were all sharply lower on the news as the sector on both sides of the Atlantic reassessed the outlook.
On the earnings front, the main focus this week will be the latest quarterly update from Nvidia on Wednesday. The leading AI chip maker has been a key driver of markets given its size and volatility. At the current $145 a share, Nvidia is valued at over $3.5trn. Current expectations are for revenues to grow 84% year on year to just over $33bn and for net income to almost double from 37 cents a share a year ago to 70 cents in the latest quarter.
If anything might persuade investors that we are not re-running 1998 it could be the remarkable earnings growth of the big US tech stocks. But with Nvidia’s shares having risen eight-fold in a couple of years, there is no room for disappointment.
