People love round numbers and investors are no exception. So it was that a broker note arrived in my inbox on Tuesday morning: “Next stop 3000,” the Credit Suisse report proclaimed.
Three thousand is the number of points Wall Street’s S&P 500 index appears destined to achieve in the coming months, if not weeks. It certainly is a reasonable guess: the benchmark measure pushed further into record territory on Monday night before stopping just shy of 2900 points.
That’s right: Wall Street is back, baby!
Investors had been grumbling about how long it had taken the usually springy US equity benchmark to regain the highs it achieved at the peak of the Goldilocks reflation trade in January.
Earnings season had been a blockbuster, and if anything better than expected. Still no new high. Emerging markets were tanking as the Federal Reserve’s tightening cycle sucked dollars back to the US and into American assets. Still no new high. The economy expanded at an annualised pace of above 4 per cent. Still. No. New. High.
Worries about President Trump’s trade war may have been expected to cast a pall over US assets, but the evidence seemed to suggest the opposite: protectionist flare-ups were met with a higher greenback.
The market appeared to be waiting for a catalyst, and they got the biggest catalyst of all on Friday night when in a lyrical speech US Fed boss Jay Powell said: “We have seen no clear sign of an acceleration above 2 per cent” in inflation.
Cue new highs.
Powell’s comments matter so much because a sudden and unexpected outbreak in long-quiescent inflation is probably one of the clearest and most present dangers to this epic Wall Street bull run.
RBA officials have warned repeatedly that financial markets seem to be underpricing the risk of a sudden end to the lowflation era.
Remember it was a rogue wages number in early February that triggered the sharp correction in US equities as investors scrambled to lift their inflation and rate hike expectations.
Here was another line from Powell’s speech on Friday night: “There does not seem to be an elevated risk of overheating“.
How much clearer buy signal do you need?
Morgan Stanley strategists are among the more bearish voices out there and so expressed some “frustration” with the recent Wall Street records. But they point out that the recent push to new highs has been led not by the usual tech names, but by defensively oriented sectors: utilities, healthcare, telcos and listed property.
New all-time highs led by defensive names is “a rare combination” they reckon, and not a particularly reassuring one.
The bond market is also expressing scepticism in the medium-term prospects for the American economy. The gap between yields on 10-year and two-year bonds continued to dwindle to last sit at 0.2 percentage points.
This “flattening of the yield curve” indicates markets are not pricing in much growth or inflation over the longer-term view, even as the Fed’s tightening pushes shorter-term yields higher.
The S&P 500 “is on borrowed time” if the yield curve goes below zero, or “inverts”, BAML analysts say, echoing the consensus view.
Inversions have preceded the past seven US recessions and nine out of the past 12 recessions. The last time it proved a false signal was in the 1960s.
So what’s the market’s real message here?
Do investors shout “3000 ahoy!” and chase new highs, or do they pay attention to the bond market and the cautious message from investors’ flight towards safer types of listed businesses?
Those Credit Suisse analysts we heard from earlier are confident there’s more in the tank.
“Investors might assume that record highs mean stretched valuations; this is hardly the case,” they write.
This year’s Wall Street gains have been all about the earnings: an 18 per cent lift in consensus earnings expectations has more than outweighed an 8.5 per cent drop in the market’s price-to-earnings valuations, they say.
They reckon the S&P 500 will advance around 1 per cent per month, which will bring the index to 3000 points by the end of the year.
The Morgan Stanley strategists believe US small caps and growth sectors such as tech and consumer discretionary are the most vulnerable to the “rolling bear market” that has struck down any number of trades around the world this year.
“But the facts are the facts and a new all-time high on the S&P 500 is hard to ignore.”