It’s all on the table — even really good news from the US

What if booming US stock markets are only getting started? After two years of catastrophising about inflation, credit squeezes, debt, recession and conflict, investors have been blindsided by a serene US expansion and record high stock indices. And some are now pondering whether they may even have been hedged the wrong way for the past year.

To be sure, 2022 was indeed a dire year for Wall Street as central banks appeared late in reining in a post-pandemic, post-Ukraine inflation spike with some of the most brutal rate rises in decades. There was a running assumption in most circles that defaults, distress and recession would follow.

Instead, the biggest economy in the world clocked a full-year inflation-adjusted expansion of 2.5% — more than 6% in nominal dollar terms and at least as fast as China on that basis in the final three months.

As AXA Investment Managers point out, the US economy is now 28% bigger in dollar terms than it was at the end of 2020. Far from slowing, annualised real growth raced at more than 4% through the second half of 2023, inflation fell back to the Federal Reserve’s 2% target on many measures, and interest rate cuts are now widely expected through 2024.

The last hurrah of a heady, overheated boom? Not so it seems. The IMF, flagging on Tuesday growing confidence in the historically elusive “soft landing” for the world economy at large, raised its 2024 forecast for the US growth rate by more than half a point to 2.1%.

At that pace, the US economy would be the fastest growing of the Group of Seven countries, expanding at more than twice the rate of the eurozone and even faster than the expected pace this year of major emerging economies such as Brazil or SA.

And even though we’re still deep in the weeds of the latest US corporate earnings season, the annual profit expansion of S&P 500 firms for the quarter just gone is coming in at about 5.5% — with expectations that full-year growth will be twice that rate, even running at triple that in the final quarter, according to LSEG estimates.

It’s little surprise then the S&P 500 index’s latest surge to within 1% of the 5,000-point milestone for the first time is starting to broaden out to midand small-cap stocks too. That’s significant as it comes after a year in which index gains were dismissed as an overly-narrow, outperformance of just a handful of mega tech firms.

AXA IM’s chief investment officer for core investments, Chris Iggo, feels upside surprises for US markets now need to be at least entertained.

“The downside is feared, rightly so, more than any fantastical upside scenarios,” Iggo told clients in his weekly note. “But it’s nice to indulge in fantasies now and again.”

Iggo throws out a series of possible additional spurs to the year — including the possibility of a significant undershoot in global inflation that sees interest rates cut faster and deeper than central banks now plan, in turn forcing holders of trillions of dollars of cash to scramble to invest in more risk.

Another “fantasy” is a possible switch of the Democrat presidential candidate from Joe Biden to someone with a better chance of preventing Republican favourite Donald Trump from returning to the White House — and likely disrupting international alliances or stoking global economic tensions even more.

“The chances of any of this happening are slim. But we cannot rule out non-linearities on the positive side as well as the downside.” He added that a put option on the S&P 500 at a strike of 3,800 in a year’s time costs more than three times the cost of a call option at a strike of 6,000.

The prospect for another leg higher is dawning on many.

BlackRock Investment Institute (BII) on Monday upgraded its broad recommendation on US stocks to overweight from neutral on a “tactical” six- to 12month view.

“The rally can run for now — and broaden out,” it said.

“Markets are pricing a soft economic landing where inflation falls to 2% without a recession,” BII said. “With markets tending to focus on one theme at a time, this narrative can support the rally over our tactical horizon and allow it to expand beyond tech. So we go overweight overall US stocks.”

Invesco strategist Kristina Hooper also contrasts the dire geopolitical backdrop to the new year with the relative strength of US financial markets.

“I’m fielding a lot of questions about the state of the economy given these global events,” wrote Hooper, and pointed instead to positives of still-robust growth, disinflation, rate cut hopes, Japanese optimism and even hopes China will move to more significant stimulus soon.

Is it time to be more wary of the boom than the bust? A glass half full at least? Not everyone is in that frame of mind yet.

Solita Marcelli, UBS Global Wealth Management’s chief investment officer for the Americas, thinks risks remain to the new year optimism and cautions about getting carried away.

“While no form of protection works for all risks, we see a range of strategies that can help mitigate volatility or drawdowns for portfolios,” she said. “These include seeking quality in both equity and bond holdings as well as defensive structured strategies, alternative investments or positions in oil and gold.”

One thing clear from this January anxiety among many asset managers is how chastening 2023 was for many of them — when an early year consensus for recession, dour equity index performance and a bond boom that all proved wide of the mark.

Perhaps the sensible thing is to just not rule anything out.