The last time we celebrated a record high on U.S. equities was seven months ago. Back then the celebration did not last long as fears of tighter monetary policy, trade tensions, and risk of a recession dominated the news headlines which led to a deep dive in Wall Street with the S&P 500 declining 20% from peak to trough in the three months leading up to December 2018.
Since then a lot has changed. The Federal Reserve took a U-turn, interest rates fell sharply, valuations became more realistic, and trade talks between the U.S. and China are moving in the right direction. These factors encouraged investors to buy the dips and begin the round trip.
The S&P 500 closed at 2,933.68 on Tuesday registering an all-time high close, and seven points away from the index’s intraday record achieved in September 2018. Yesterday’s rally was driven by a better than expected Q1 earnings performance with Coca-Cola, Procter & Gamble, United Technologies, Lockheed Martin and Twitter all beating estimates. With more than 78% of S&P 500 companies thus far surpassing Wall Street expectations, the chances of escaping an earnings recession are becoming more likely.
Many investors, especially those who remained on the sidelines may be asking whether the bull trend will resume, and thus participate in this bull run. Predicting the next move with certainty is a mission impossible. However, if you are a contrarian there are many indicators which lead us to believe that the current bull market may not last for long.
The current bull market was built on the assumption that the Federal Reserve will no longer raise interest rates in 2019 and in fact, may even lower rates by the end of this year with investors expecting a 55% chance of a rate cut. If this assumption is proved to be wrong and higher energy prices boost inflationary pressures, we may gradually see the Fed changing its course. Such an outcome will lead to a significant repricing of risk assets.
Stimulus from China is also expected to be reduced after Q1 GDP data has shown the economy is growing at healthy levels. Fewer stimulus measures from China will not likely help the global economy bounce back strongly as previously anticipated and therefore reduce appetite for equities.
Shares buybacks in 2018 were an important component of the equities rally. Last year S&P 500 companies spent more than $800 billion on buybacks compared to $519 billion in 2017. The passage of the tax reform package has been a key factor for many companies to repatriate cash and boost buyback activity last year. This component is no longer available and if share buybacks reduce significantly, investors may see it as a negative sign.
I’m not saying that markets may not go higher from current levels, in fact we may see equities posting new record highs if earnings continue to surprise to the upside. However, in my opinion, this is not the most loved bull run.
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This article was originally posted on FX Empire
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