Longest ever US bull market?

By David Morrison  |  22/08/2018 15:01

If the S&P 500 closes out tonight without crashing by 20%, then the US will record its longest ever bull market run in equities

US stock index futures were all lower ahead of Wednesday’s open. The selling came after President Trump was in receipt of a double dose of bad news. His former campaign chief, Paul Manafort, was found guilty of tax fraud and several other crimes. Meanwhile, Michael Cohen, Trump’s former lawyer, pleaded guilty not only to tax fraud but to campaign finance violations. The latter are understood to relate to ‘hush money’ paid to Stormy Daniels and The National Enquirer to silence claims about ‘a candidate’s’ (widely understood to be the president) extramarital affairs.

Longest bull run

Despite this, most of the US majors (putting aside the Dow) remain within spitting distance of their record highs. In addition, today’s close should see the S&P 500 mark the longest US bull run* in history, assuming it doesn’t ‘flash crash’ in the next few hours.

Divergence

The performance of US stock indices continues to diverge from those across Europe and the Asia Pacific region. This is aside from the obvious divergence already evident between developed and emerging market indices. As things stand, it appears investors are perfectly happy to add to their US equity exposure at the expense of other global markets.

Tariffs positive for US?

The argument goes that the Trump administration’s tariffs are positive for the US while decidedly negative for China, let alone other tariff targets such as the European Union, Canada and Mexico. Certainly, that would be the immediate takeaway if one simply compared US stock indices to other global indices. The Trump administration seems less likely to grant any trade concessions to China if it appears that the tariffs imposed so far are boosting US companies at the expense of Chinese ones. For this reason alone, it could be that the two days of trade talks between the US and China, which begin today, will bring little in the way of good news. Bear in mind that both countries have timetabled fresh tariffs against each other for Thursday. But the market response to yet another breakdown of trade talks is uncertain. Investors have the bit between the teeth and seem determined to push US equities to fresh record highs to celebrate this historic bull run.

Reasons to be bullish

Of course, there are good reasons for investor bullishness. Second quarter US GDP growth came in at an impressive +4.1% while Trump’s tax cuts have helped boost corporate profitability. The second quarter earnings season (which is coming to an end) has been impressive. The latest analysis from FactSet (10^th August) showed that of the 91% of S&P 500 companies that had reported to date, 79% had positive surprises on earnings with 72% positive on sales. Earnings growth for Q2 came in at 24.6%, which, if it holds, would be the second highest since the third quarter of 2010.

But concerns exist

However, it wasn’t all good news. For a start, 55 S&P 500 companies gave negative forward guidance for the third quarter against 19 positive. This suggests that the second half could disappoint, particularly as the year-on-year comparisons will prove challenging given strong results in the last six months of 2017.

Buyback boost

One of the driving forces behind the US rally has been stock buybacks. Corporations are awash with cash. But rather than reinvest this in tech updates, plant and machinery or staff training, corporate executives have chosen to reward themselves and their shareholders with dividends and buybacks. Buybacks essentially take shares off the market, making them scarce when demand is already high and thereby pushing up prices further. This is great for holders of stock and stock options, but it removes liquidity and distorts the market. At the same time, the US Federal Reserve is in the process of reducing another distortion as it tightens monetary policy through rate hikes and running down its balance sheet. This means there are fewer dollars to go around, just as investors demand them to buy US equities and other assets.

Speculative positioning

It’s worth noting that the latest data from the Commitment of Traders report shows that Non-Commercial speculators are longer of the US Dollar Index at any time over the last twelve months. At the same time, they have never been more bearish of US Treasury notes. In other words, they expect interest rates to rise, even as yields have fallen recently, inflation may be topping, and the yield curve is the flattest it’s been since August 2007. If these large speculators see these markets shift against them, then the move to cover or reverse their positions could be sudden and severe. Yet again, it may pay to be cautious.
 
*A bull market defined as one which has risen 20% or more from its lows until it drops 20% or more from its highs.
 
 
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