Signs are growing that the US bull market is running out of steam. If you invested $100 at the low in 2009, when the S&P500 index was around 800, you would now be sitting on $300, with the index currently just above 2500. This has been the second-best US stock market rally ever. But is it coming to an end?
Year-to-date, the S&P500 is up around 10 per cent: better than the indices for Europe, the UK, China and Japan. However, much of that performance has been driven by a handful of tech stocks. Just five companies — Facebook, Amazon, Apple, Microsoft and Alphabet (parent of Google) — added more than $600 billion to the valuation of the US stock market in the first half of the year, accounting for a third of the uplift in the S&P500.
Looking at the much broader Russell 3000 index, a benchmark of the entire US stock market, the story is much the same. By the end of August, the Russell 3000 was up 9 per cent year-to-date but almost half of its constituent shares were actually trading lower than at the beginning of the year — the rise was concentrated in the other half. And this narrowness of the equity rally is causing investors’ concern.
It could also be argued that US dollar weakness — down 14 per cent against the euro so far this year, 6 per cent against the yen, 5 per cent against sterling — is increasing US corporate profits as overseas earnings are boosted when converted back, so artificially boosting share prices. And there’s another reason to think that US stocks may be peaking: executives at many of the companies appear to think so, and have significantly reduced share buybacks — that is, using spare corporate cash to buy in their company’s shares, which is generally done when executives feel the shares are undervalued.Bloomberg says share repurchases are 20 per cent lower this year than last, and back to 2012 levels.
Those share buybacks have been an enormous prop to the US bull market: Citi estimates that US companies bought back nearly $3 trillion of their own shares between 2010 and 2016. That was a lot of buying, and it’s now in decline.
And it’s not just the executives running the companies who worry the shares are fully valued. The world’s most successful investor, Warren Buffett, is currently sitting on almost $100 billion of cash, waiting for investment opportunities at the right price.
US corporate profit margins have never been higher, which would generally suggest they are likely to fall. And many commentators feel the market’s price-earnings ratios look stretched.
US value fund manager GMO said in a recent research note: ‘This is the third most expensive market in history. The only times we have seen more expensive US equity markets were 1929 and 1999 [just before great stock market crashes, that is]. Strangely enough, we do not hear many exhortations to buy US equities because it is just like 1929 or 1999.’
Increasingly, investors are backing ‘short-selling’ trades that bet on the US market falling. As Bloomberg noted on 30 August: ‘Short interest is up in 2017. As a proportion of total shares available for trading, it has climbed by 0.4 per cent points to 4 per cent.’
And there are plenty of other risks in play. Investors’ faith in Donald Trump has been declining as his behaviour has become increasingly unpresidential. There has been no legislation to fertilise the boost to US economic growth that he promised on the campaign trail. There is little optimism that he’ll drive significant tax reform any time soon. And although Congress agreed a slight increase to the US debt ceiling to help victims of Hurricane Irma, this is just a temporary sticking plaster. In December, the new higher debt ceiling is expected to be breached, potentially resulting in a partial government shut-down. Republicans control Congress under a supposedly Republican President, but they face the same political gridlock as Obama.
And that’s before we get to the geopolitical risks, with North Korea top of the list. Add on a central bank that is tightening monetary policy, albeit at a snail’s pace, and there’s plenty to worry about.
Having said all of this, there are still plenty of bulls out there. Interest rates globally are barely above zero, forcing investors away from bonds and into equities. And it’s also all but impossible to pick the top of a bull market. Almost all research points out that it is better for investors to stay invested for the long term and not try to time the markets. Not even legendary US Fed chairman Alan Greenspan was smart enough to call the top: he rightly warned of ‘irrational exuberance’ and ‘escalating asset values’ — but in 1996, four years early for the dotcom crash of 1999-2000. Nevertheless, right now
I have a bad feeling about US equities.