American stock market’s latest high is baffling investors
As Jared Woodard, a Bank of America investment strategist, starts work each day in Manhattan, he already knows what investors will call to ask.
Why has the US stock market hit record highs while investor confidence, reacting to a worsening economic outlook, has deteriorated?
“It’s the most frequently asked question we’ve had this year,” Woodard said. “Investors we speak to are incredibly cautious. They see the market rally but they don’t trust it.”
US growth slowed in the third quarter as business investment kept weakening, adding to concerns the global economy rests on a knife-edge.
But the S&P 500 moved above its summer high this week, and set another record on Friday after the latest monthly jobs report. The US added 128,000 non-farm payrolls in October, fewer than 180,000 in September but enough to send the equity market benchmark up 1 per cent, capping a 22 per cent rise this year. If this performance holds until the end of December, it would be the S&P 500’s second-best annual return in 10 years.
Other market indicators seem more responsive to the economic picture. The closely monitored yield curve of US government debt inverted this year, a sign that has foreshadowed recessions over the past five decades, and a capital squeeze in the market for overnight bank lending has caught the Federal Reserve off-guard, forcing it to inject billions of dollars of liquidity.
Nervous investors have continued to rush to their favourite retreats, including cash and low-risk bonds, sending yields plummeting. This has swelled the universe of negatively yielding debt to US$13.5 trillion ($21t).
“It’s hard to think of a better measure of pessimism about global growth,” Woodard said.
Set against the gloom, the US stock market’s meteoric rise is “a fantastic dichotomy”, said Woodard.
A series of rate cuts by the Fed — including a quarter percentage point cut last week, the third this year — and cautious optimism that the US and China will resolve the trade stand-off have pushed stocks higher.
The Fed’s decision to increase temporary liquidity injections to US$120 billion a day from the current US$75b have added more support for stocks, said Nick Maroutsos, of asset manager Janus Henderson.
The stock market has a record of pricing in today what will happen soon. But given the weak growth outlook, this pattern is being called into question, said Alessio de Longis, a senior portfolio manager at fund manager Invesco. “There is a disconnect between where the market is going and where the economy is heading,” de Longis said.
Thus investors should look instead to the bond market to understand why stocks continue to climb. The debt market, highly sensitive to bad news, has been raising red flags about slowing domestic and international growth as reflected in sliding yields.
Major central banks responded quickly to the deteriorating economic outlook with aggressive monetary policy action in the form of interestrate cuts and bond-buying. This seems to have reassured investors.
Yields on Japanese, German and Chinese government debt edged up as investors sold bonds in favour of riskier assets. Analysts now think this trend is reversing.
Corporate activity is another part of the puzzle. US corporate profits fell in the first and second quarters, sending them into an “earnings recession”, says FactSet data. It expects this trend to continue into the third quarter.
Balancing that, stock buybacks — where a company repurchases its own shares — continue to provide support to the stock market.
In the third quarter alone, firms are expected to spend about US$170b on their own stock, shows of S&P Dow Jones Indices data. “When the market reaches new highs there is a ‘ fear of missing out’ trade,” Woodard said.