While 2020 has been no-one’s idea of smooth sailing on the markets, the last two months have at least seen US shares veering back from their March dip. And with a vengeance.
At one point in June, the S&P 500 – the index of the 500 biggest publicly-listed companies in America – had shaken off the entirety of its coronavirus losses. By that measure at least, America’s economy looked back on track. And investors were understandably buoyed.
But should we be so confident that this is a sustained recovery, rather than just a short-term rally? With coronavirus cases increasing again, and America facing political uncertainty at home and abroad, could things be about to get a lot worse before they get better? That was the scenario predicted by The Spectator’s business editor, Martin Vander Weyer, last month.
Even leaving the virus aside, analysts have long been raising alarms about America’s seemingly gravity-defying bull market, which has seen markets rise for the past eleven years straight. Ross Mould, investment director for AJ Bell, understands their fears. He points out that, according to many well-respected predictors of economic performance, America’s stock market appears ripe for a tumble.
In particular, he points to a Nobel-prize winning measure called CAPE – otherwise known as the cyclically adjusted price-to-earnings ratio – which has historically predicted whether markets are over- or undervalued. Right now, the CAPE ratio is as high as it’s been since just before the dot-com crash. Hardly a reassuring sign for investors.
Then there’s that other big structural uncertainty: the increasing dominance of big tech stocks. Given the FAANGs (that’s Facebook, Apple, Amazon, Netflix and Alphabet/Google) now account for a whopping 20 per cent of the entire S&P 500, analysts worry that the supposed recovery could be greatly exaggerated. Particularly given that, unlike the rest of the economy, the FAANGs have thrived during the pandemic.
Perhaps it’s no surprise, then, that a renewed pessimism is gaining traction on Wall Street. A monthly survey by the Bank of America found that 78 per cent of US fund managers now fear the market is overvalued – the highest number since the study began in 1998.
Despite what CAPE might say, those bullish about future growth have a seriously big player on their side: US monetary policy. ‘In the recent past, tools like lower interest rates and quantitative easing have blotted out of a lot of fears about an overvalued market,’ Mould says. He points out that – this year alone – the Federal Reserve and Congress have provided some $6 trillion of stimulus to keep markets liquid. And so far, it’s worked.
Understandably many investors see the Fed’s willingness to act as a good reason to get stuck in. John Redwood, the Conservative MP and chief strategist with investment house Charles Stanley, has noticed the same phenomenon. ‘Thanks to the huge injections of new money from the Fed there is a large gap between economic reality and market levels,’ he says. The question, he says, is the extent to which that support is maintained. Quite.
But could the Fed’s soothing medicine be distracting us from even bigger risks to the global economy? In the pre-corona era, one of the few stories with the potential to spook the markets was the prospect of a US-China trade war. And while those tumbles were usually drowned out in a period of booming growth, experts worry that we might not be so lucky next time.
Adam Ward is a China expert who previously headed up research for the Chatham House think tank. He predicts that a great power struggle between the US and China could lead to a fundamental shift in the global economy.
His theory is that, unless the rival superpowers can reach an acceptable detente (a prospect he views as unlikely), we will inevitably see a surge in geoeconomic warfare between the two. ‘Tariffs and sanctions will be more widely employed in pursuit of national interests, while trade relationships will focus on political affinities rather than economic complementarities,’ he says.
The increased use of these kinds of measures will play havoc with trade itself. ‘Weakened international institutions like the WTO will be less able to absorb tensions or adjudicate disputes. And global businesses will be dragged more deeply into the fray,’ Ward says. All of which effectively amounts to one thing: an end to the economic certainties that have seen stocks rise on both sides of the Pacific.
Though there is at least one other more immediate political uncertainty which investors shouldn’t worry too much about. US presidential elections – even ones as contentious as this one is likely to be – don’t have a habit of moving the markets too much. Data suggests that, though the markets tend to prefer an incumbent, Democrat presidents average higher returns on the market. The difference, in either case, is effectively minimal.
With everything else going on, investors can at least breathe a sigh of relief on that front. For now.