Stop me if you’ve heard this before. The major stock market indexes rose to records again this past week against a backdrop of domestic political fights and global geopolitical tensions. It almost appears as if the equity market resides in a separate universe.
The irrepressible and reliably bearish Doug Kass, who runs Seabreeze Partners Management, suggests (with tongue firmly in cheek) that there is some outside force at work that continues to lift stocks ever higher. As the industrials topped 28,000 on Friday, talk of the Dow Jones Industrial Average (.DJI) at 30,000 didn’t seem so fanciful as when Barron’s suggested it in January 2017, as the blue chips hit 20,000, right around when President Donald Trump was inaugurated.
Now, even as the House of Representatives is holding impeachment hearings, stocks continue their ascent unimpeded. The clearest explanation is that, while the Democratic-controlled House is likely to vote articles of impeachment, it is even more certain that the Republican-controlled Senate would find the president not guilty.
Bill Clinton’s impeachment and trial in 1999 barely registered a blip in the roaring bull market and long economic expansion of that decade. In contrast, the Watergate hearings came against the backdrop of the vicious 1973-74 bear market during a steep recession and high inflation amid the oil-price shock and gasoline lines that, along with the Vietnam War, offer the indelible images of that decade.
The impact on the market of the current political fights, however they turn out, might not be what’s expected. Wall Street’s biggest worry is that one of the leading Democratic presidential hopefuls on the left, Sen. Elizabeth Warren (D., Mass.) or Sen. Bernie Sanders (Ind., Vt.), could win the White House and have their soak-the-rich tax agendas enacted.
Odds are against Warren and Sanders doing that, even if one wins, especially if the Senate stays under GOP control. Moreover, the impeachment effort could hurt them, writes Stephen Pavlick, Washington policy analyst at Renaissance Macro. Should the president be impeached by the House, the Senate trial would require senators to be in Washington. Warren and Sanders would benefit more from campaigning in Iowa and New Hampshire, he notes.
If politics aren’t behind the stock market’s climb to records, then surely it must be corporate earnings, right? Who cares about D.C. dysfunction if the profits are rolling in? But that’s not necessarily the explanation, either.
“A review of how S&P 500 (.SPX) prices interact with S&P 500 earnings suggest that earnings have little to no impact on near-term index performance,” writes Doug Peta, chief U.S. investment strategist at BCA Research. Over the long term, earnings and stocks move in sync, but cyclical forces dominate. Monetary policy provides useful insight into future moves in earnings and price/earnings ratios, he concludes.
On that score, the outlook is positive. Federal Reserve policy will probably remain on hold after three one-quarter-percentage-point interest-rate cuts and as the central bank tries to alleviate liquidity shortages resulting from the previous reduction of its balance sheet. That was the message in Fed Chairman Jerome Powell’s congressional testimony during the past week.
That is also the view of the federal-funds futures market, according to the CME FedWatch site, which doesn’t put the odds of another rate cut at significantly better than even money through most of 2020, at least not until after next November’s elections. The outlook perhaps was best summed up by Yuong Ha, chief economist of the Reserve Bank of New Zealand: “We expect interest rates to remain low for a long time, and it’s a global phenomenon.”
Not low enough for Trump, however. In a speech to the Economic Club of New York, he renewed his call for the Fed to match the negative interest rates of Europe and Japan. Since the U.S. had the strongest economy, he contended, it should have low rates. Ultralow rates, however, are actually a symptom of economic debilitation. In 1984, long-term Treasury yields touched 14%—10 percentage points above inflation—when it was “morning in America” during President Ronald Reagan’s landslide re-election.
While rates are likely to remain low worldwide, “the global economic backdrop has, for the first time in 18 months, begun to improve,” writes Michael Pearce, senior U.S. economist at Capital Economics. It’s not just because of prospects of a trade deal. Recession risks have, well, receded. Growth may slow to a 1% annual rate in the current quarter, but odds of falling into an outright recession have slid.
At the same time, the risks from financial excesses still appear moderate, according to Goldman Sachs economist David Mericle. Commercial real estate risks have eased, helped by slower price appreciation and better rents. Corporate debt is high, compared with gross domestic product, but a better comparison is debt versus earnings and assets. “Those metrics are not at alarming levels, even for high-yield issuers,” he adds. As for federal debt, trillion-dollar deficits no longer raise eyebrows, in Washington or on Wall Street.
UBS Wealth Management’s chief investment officer, Mark Haefele, no longer favors underweighting U.S. equities in the bank’s recommended global portfolio. “Despite higher prices and the downside risks in evidence, upside also has increased, in our view,” he says. The market evidently agrees, as it continues to set records.
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