Inside the Broker - US stock indices continue their advance
Inside the Broker
US stock indices continue their advance
As we head into November and creep ever closer to the year-end, the major US stock indices continue to post a succession of fresh record highs. Yet this latest equity market rally came from inauspicious beginnings, with September posting losses for the Dow, S&P and NASDAQ 100 of 5.8%, 6.9% and 7.3% respectively. But the major indices all hit their low points at the beginning of October. Since then, up until this Monday, we’ve seen the Dow rally 8.8%, the S&P rise 10% with the NASDAQ recording a gain of 12.1%. The bulls have been encouraged further by recent price movements in the Russell 2000. The Russell lagged the three majors by trading sideways after hitting its own record high in mid-March this year. Then in early November it suddenly broke out of its trading range to hit uncharted levels. In fact, it has outperformed all the other indices since early October by rallying 12.8%.
This is quite significant. The Russell 2000 is a broad-based index of what the US calls ‘mid-cap’ stocks, that is, companies with considerably smaller market capitalisations than most of those constituting the big three indices. In addition, the stocks in the Russell 2000 are far more domestically focused than the big world-dominating companies found in the Dow, NASDAQ 100 or S&P 500. Consequently, the fresh record highs now being posted by the Russell suggest a big vote of confidence in the US economy. The feeling is that the worst of the Covid-19 situation is over, and that US corporations should continue to surprise on their revenues and earnings. For some analysts, this was the last piece of the jigsaw when it comes to bullish confirmation. The other significant index which often flies under the radar, the Dow Jones Transportation Average, took out its previous all-time high on the 25th October, just over a week before the Russell.
This is all good news, as was the Federal Reserve’s announcement last week that it would start winding down its $120 billion per month bond purchase programme. While this taper obviously means reduced monetary stimulus, the market reaction was positive. Firstly, because it surprised no one. Secondly, it was seen as a big vote of confidence in the US economy. Further evidence of US economic strength came on Friday with some truly stunning Non-Farm Payroll data. The headline number showed a payroll increase of 531,000 for October, miles above the 450,000 expected. In addition, the two prior readings were revised substantially higher by a total of 235,000. Putting everything together, this data means that US payrolls are 4.5 million below pre-pandemic levels. That may sound a lot, and the US central bank has said that it wants to see unemployment return to pre-pandemic levels before it starts raising interest rates. But it is worth considering that at the end of 2019, US unemployment fell to its lowest level in 50 years. This was just months before we became fully aware of the coronavirus. A return to pre-pandemic levels of employment would be a significant achievement. But there’s the danger that inflation could continue to rise ahead of this, putting pressure on the Fed to raise rates anyway. That could be a headwind.
As the US stock indices continue to push higher, a growing number of analysts are warning that the world is gearing up for a crash. Inflation is a concern, particularly as the typical response is to raise the cost of borrowing. In addition, it’s certainly true that many equities look overvalued. Tesla is an obvious example. We have rampant speculation, not just on a host of cryptos, but on more nebulous assets such as Non-Fungible Tokens. Then there are warning signs from China where Evergrande, one of its biggest property developers, is in deep trouble. Bear in mind that the Chinese economy is built on a highly leveraged property market. So, there’s plenty to worry about. But often markets climb on a wall of worry. We had a significant melt-down less than two years’ ago, and the recovery since then has been stunning. The big question for investors is to consider whether we are due another crash. Or if not, perhaps a significant pull-back to clear the air and rebase index levels. September’s sell-off rattled confidence for a few weeks. But it didn’t officially make it into correction territory, which is defined as a fall of more than 10%. Perhaps that’s what we should be preparing for. Or can this rally continue to infinity and beyond?
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