Nearly 20 years ago in 2007, just before the financial crisis, the then-boss at investment bank Citi famously said: ‘as long as the music is playing, you’ve got to get up and dance’.
With that, Chuck Prince had made an era-defining comment, a bit like the one from Irving Fisher, a US economist, who said in 1929, just before the Wall Street crash, that: ‘stock prices have reached what looks like a permanently high plateau.’
Another week, another high
The music is certainly still playing in global stock markets. Last week, the S&P 500 closed at 6,664, yet another all-time high. The US index is 17% higher than a year ago, and nearly 35% up on the April low that followed Donald Trump’s announcement of swingeing trade tariffs.
And it is not just the US market which is soaring. Since April, Japanese shares have risen by more than 35% too, while European and Chinese stocks are more than 20% up in less than six months. Even here in the UK, where we face uniquely difficult economic circumstances, shares are 16% higher than they were in April, and 12% year to date.
Risk appetite has spread around the world, and across all asset classes. The extra income demanded by investors to lend to riskier companies rather than safe governments is at a historic low. Within the stock market, the best-performing shares are the riskiest and most speculative, non-profitable businesses. Gold and bitcoin are hitting new highs.
What is driving markets higher is a rare combination of rising earnings, higher valuations and the expectation of lower interest rates.
On the earnings front, second quarter earnings emerged better than expected and, just weeks away from the third quarter results season, the forecast is for a 7% year-on-year rise in profits. Recent history suggests that figure will rise as results season unfolds, so another quarter of double-digit profit gains looks likely.
That’s helped push valuations higher, but not yet to levels comparable with those reached in previous market booms like the late 1990s dot.com bubble. And, meanwhile, last week’s interest rate cut from the US Federal Reserve (Fed) confirms expectations that the cost of borrowing is heading down again as the economy and jobs market starts to slow.
Stocks higher, dollar down
The one asset which is not benefiting from this combination of factors is the US dollar which has fallen by around a tenth this year. For many investors, that too is a positive. A weaker US currency is often associated with outperformance for emerging markets. It cuts the burden of US-denominated debts, and it boosts commodity prices, which are a big contributor to emerging economies.
A falling dollar makes a strong case for a more diversified portfolio. Other things being equal, it reduces the value of US investments for overseas investors. It will encourage a rotation out of US assets, particularly for investors in places like Japan which sought safety in America while their own currency fell in recent years and interest rates at home were low. Outflows will make it ever harder to justify the premium rating of US stocks.
Quiet week ahead
This week will provide a few data points, or corporate earnings announcements, to either confirm or undermine investors’ optimism. The main focus is likely to be on US inflation, with the announcement on Friday of the Fed’s preferred measure, the personal consumption expenditures (PCE) index.
This will be the first test of Fed chair Jerome Powell’s assertion last week that the labour market, not inflation, is the central bank’s biggest concern now. The PCE index is expected to have risen slightly in August from 2.6% to 2.7%. That’s above the Fed’s target of 2%, but hardly a big concern at the current level.
