As we move into the autumn months, it’s worth looking more closely at the US stock market, which appears to have disconnected from other risk markets. For example, Amazon made a fresh record high on Tuesday and became another trillion-dollar company. In contrast, the South African rand is close to a record low and has fallen 4% since the start of this week, and the EM space generally is suffering from sharp losses.
But is the US’s equity market dominance likely to continue? We argue that there are four reasons why investors need to be wary about expecting US indices to only move in one direction.
1, markets tend to be mean reverting: this means that when they go up they must come down. The market is not, yet, looking at the nitty-gritty of US politics and the US economy and the potential that a bubble is forming that one-day will be popped. However, even if the popping of the bubble is some way off, investors need to be aware that the market could see a correction in the coming weeks.
2, The inversion of the yield curve: although this hasn’t impacted US stocks indices yet, the fact that the bond market is anticipating an economic slowdown in the future, hence why 2-year yields are higher than 10-year yields (which is causing the curve inversion), will come on to stock investors’ radars at some point soon. If the curve continues to invert then we will know who to blame for the popping of the US stock market bubble: the Fed.
3, Earnings : Q2 was a bumper earnings season for US companies, who were boosted by the US tax cut. With earnings growth for all sectors on the S&P 500 a whopping 25.25%, surely we are near peak earnings season for the US?
4, Risk events: this is where the US markets could come unstuck. The markets expect another rate rise from the Federal Reserve on 26th September, and rates are expected to rise to 2% with a 96% probability, and there are growing expectations that another rate rise could be on its way in December. With the cost of capital rising dramatically in 2018, how long can US stocks continue to march higher before the prospect of rising interest rates causes the economy to cool and stock markets to sell off?
The US mid-term elections on November 6th are another major risk event. The Trump tax cut has undoubtedly been good news for US stocks, however there is an even chance right now of the Democrats taking control of Congress, which could mean that Trump’s plans to push through further tax cuts or business-friendly policies could be thwarted. If there is a major backlash against the President then it may also reduce his chances of winning a second term in office in 2020. This may cause fears in financial markets that the Trump tax cuts could be reversed, which may lead to sharp stock market declines in the aftermath of the mid-terms.
To conclude, US stocks do not live in an ivory tower, they have plenty of risk factors that could trigger a decline, it’s just that the market is not focusing on these issues right now. However, once the EM sell off has run its course, as we expect it to do in the coming days and weeks, the focus will be on US stocks and the points we list above, which leaves them ripe for a correction in the coming months.
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