A Strange Record

The stock market hit an all-time high last week but there doesn’t seem to be much fanfare. After seven-and-a-half years and a 215% increase, the current bull market has been branded the most unloved ever. So far this year, the S&P 500 has rocketed nearly 20% from its February lows to establish a new price record, yet fund flows have poured into bonds rather than equities and investor sentiment is tepid. What gives?

Typically, a new price high is confirmation that something is going right, that the market is forecasting a bright future. Indeed, this is why it is considered to be a leading economic indicator: It has a track record of correctly calling the economic environment over the subsequent six to twelve months.

So, why the lack of enthusiasm this time around? One answer is that the market high comes amid a dizzying array of negative news, calling its durability into question. Some highlights:

  • Brexit – The S&P 500 is up 8% since the initial decline after the UK referendum vote to leave the European Union. But big unknowns are how the extrication process will unfold and its knock-on effects on UK trade and London’s standing as a world financial hub. A recent International Monetary Fund economic downgrade forecasts a GDP hit of 0.3% to the Eurozone in 2017 because of Brexit, slowing next year’s growth to 1.4% from the previous 1.7% estimate.
  • China – The economic transition underway in the world’s second largest economy continues apace. Q2 2016 GDP increased 6.7% for the second straight quarter but debt-as-%-of-GDP has ballooned to 240%. Another shock like the summer of 2015, during which the Shanghai Index fell nearly 45%, may be hard to avoid given the systemic risk.
  • Earnings – Q2 earnings are estimated to fall 5%, which is the 5th straight quarterly decline and something that hasn’t happened since 2008-2009. Revenue growth, as well, will fall -0.9%, registering a 6th straight quarter. This is a strange backdrop for new market highs, to say the least.
  • US growth – The US economy grew 1.1% in Q1 and the estimate is for 2.4% in Q2, this after logging 2.4% in 2015 – a far cry from the 3-4% growth of the average post-war cycle. Economic growth is so muted that the Fed, ostensibly in a tightening mode, isn’t comfortable raising rates from a rock-bottom range of 0.25%-0.5%.
  • Political uncertainty – A volatile and fractious political environment in the US and a rise in populist movements globally increase the risks of policies that are negative for business and free trade. At minimum, the uncertainty tends to stall capital investment as companies look for more clarity.
  • Interest rates – Typically, stocks and bonds don’t reach price highs at the same time. But this is perhaps the best illustration of the current strange environment. On July 5 ,10-year Treasuries hit a record low yield of 1.37% and currently 30% of global bonds – or $13 trillion – have negative yields. This is unprecedented.

Bull markets always occur against a backdrop of uncertainty. The Wall Street adage is that the market continually “climbs a wall of worry.” And its true that there are always good reasons at any given time for stocks not to go up, economic, political, or otherwise. But the current favorable environment for stocks seems to be a uniquely unstable combination of a Fed on hold, low but steady employment and economic growth, and an absence of global investment alternatives.

Of course, this doesn’t mean it can’t continue to go up. But investors are right to be nervous.

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