Trader's view - Wall Street celebrates record highs (again)

Wall Street clocks new highs

Wall Street achieved a milestone overnight: it registered an all-time closing high. It in some way punctuates one of the more bemusing runs in US equities, following (what felt like) the near-cataclysmic market correction at the end of 2018. The S&P 500 closed at 2933 this morning – a mere 10 points from that index’s all-time intraday high. As had been expected, the catalyst for US stocks’ latest burst higher came directly from US reporting season. A series of companies, including the likes of Coca-Cola, Twitter and Procter and Gamble, beat analysts’ expectations, inspiring hope that the feared “earnings recession” isn’t confronting the market after all.

Can the good times last?

The natural question to ask in these circumstances is: how far further can this run? This is especially pertinent give that the last two occasions Wall Street hit record levels, it was followed by major market corrections. A familiar point too: the previous market pullbacks were characterized by the evacuation of momentum chasers from the market, after US indices began to test “overbought” levels, somewhat like they are beginning to do now. The growth and earnings outlook then, as compared to what it is currently, was also much more favourable, giving credence to the notion that this market isn’t being supported by strong enough fundamentals.

Valuations are (relatively) favourable

Of course, it’s impossible to predict these things with any certainty; however, for US equity bulls, confidence can be taken from a few facts. The first, is that that valuations aren’t looking quite as stretched as they were in February 2018 and October 2018 when the last two corrections hit. As of today’s close, the S&P 500’s price-to-earnings ratio of 19:1 is markedly below the 24:1 and 21:1 that defined those two market-corrections. Furthermore, yields are still attracting flows into stocks over other asset classes, with the S&P500 still boasting a relatively attractive 1.89% yield overall.

The core risk missing this time

As might be inferred from these statistics, the key risk absent now as compared to when the S&P 500 hit its last record highs is the prospect of interest rate hikes from the US Federal Reserve. One might even suggest that the cause of and solution to Wall Street’s volatility has been the Fed. Recall: the February 2018 market correction was sparked by a surprise increase in US wage growth that forced bond markets to price in the greater prospect of Fed rate hikes; and the October 2018 market correction came subsequent to Fed-Chair Jerome Powell’s now infamous “a long way from neutral (interest rates)” comments.

The Fed unlikely to remove the punchbowl

It was the unwinding, if not flat-out reversal of the Fed’s policy bias, that inspired the most recent ascent to all time highs for the S&P 500. And as opposed to the corrections of 2018, the chances that the Fed will “pull away the punch bowl” as this party is getting started is quite low. Instead, the muted inflation outlook, combined with economic and policy related realities, has led market participants to bet that the next move in US interest rates will be a cut. Hence, financial conditions are likely to be supportive of risks assets, with the key now ongoing economic, and corporate earnings growth.

ASX to join the party?

In light of Wall Street’s quick-sip of euphoria, SPI Futures are suggesting that the ASX 200 will back up yesterday’s strong showing and add around 20 points at today’s open. Though missing true volume through the market, the ASX demonstrated signs of robustness during Tuesday’s session, with breadth solid at 76%, every sector in the green, and the major energy, mining and financials stocks all adding substantially to the index. It was enough to push the ASX 200 into and beyond the 6300 level, and clock highs not witnessed for Australian stocks since September 2018.

Event risk centres on Australia today

A few supportive inter-market variables have underwritten the strength of Australian stocks this week: a tumble in the Australian Dollar, and Australian Government Bond yields. Arguably, it's in anticipation for today's headline event-risk that this has been so: quarterly local CPI figures. Though not as significant as labour market data to the RBA, the inflation numbers will offer some insight into the RBA's potential next move. Australian inflation, as it has been globally, has been stubbornly low. A matching or missing of today's 1.5% estimate for CPI only adds weight to the idea the RBA's next move will be a cut.