US euphoria
Donald Trump’s re-election has created an asymmetric shock on the markets, to the advantage of Wall Street and to the detriment of the rest of the world. What factors have buoyed Wall Street since the election, and what are the risks?
Reminiscent of 2018, when the US administration simultaneously embroiled itself in a trade war and lowered taxes, equity markets have experienced an asynchronous shift since the elections on 5 November. Wall Street, with gains of more than 20% since the start of the year, rose by an additional 4%, while non-US equities fell by around 1% (cf. chart 1).
In the United States, the market was mainly driven by the financial sector (+10%, cf. chart 2), the second largest sector after infotech, in light of anticipated sectoral deregulation. Bolstered by Tesla, the consumer discretionary sector also shone. The Russell 2000 Index of small-cap companies also rose significantly, although once again this was mainly driven by small financials. However, the two sectors that had been the most promising since the start of the year – infotech and communication services – have benefited little from the political changes.
After two years of strong US stock market recovery and marked outperformance compared to other global markets, should we be worried about “overheating” on Wall Street? For example, investors will not have forgotten that the American exceptionalism of 2018 ended badly, with the S&P 500 correcting by 20% in the fourth quarter. Fears of a similar downturn – short-lived as it ultimately was – are all the more present today, as the valuation of US equities is increasingly fraught. Excluding the COVID year, it is at its highest since 2001 in terms of PER, despite long-term real rates having risen to their 2007 levels (cf. chart 3). As a result, the risk premium for equities compared to government bonds has fallen to just over 2% today, which twice as low as its historical average. However this premium is still higher than its 1999/2000 level, when it dropped below 1%.
Several factors have the potential to spark a correction. These include the potential disappointment should the domestic political agenda fail to deliver on corporate profits, an overly aggressive trade war that would weaken growth prospects, and finally a precipitous rise in interest rates. With regard to the latter, the market’s recent momentum has been largely reassuring, with 10-year rates falling over the last week (cf. chart 4). Among the favourable factors, the Personal Consumption Expenditure deflator remained close enough to 2% in October to keep the commonly accepted hypothesis of moderate and gradual Fed rate cuts intact. As such, we are maintaining our exposure to equities in our global portfolios as it stands at this stage. We are nevertheless keeping a watchful eye on inflationary and trade outlooks, and on the risk of economic overheating that could spell the end of rate cuts by the US Federal Reserve.
