For US stock market investors, 2020 has started off on a similar footing to how 2019 ended. The US is the best performer of all the major global equity markets. It has continued to attract investor fund flow, thanks to strong momentum, FOMO (“fear of missing out”) behaviour, and a realisation that the US offers secular growth opportunities in a world of negative interest rates. Even the coronavirus outbreak hasn’t yet completely shifted the narrative, with any market pullback associated with the virus being used by investors as a reason to buy stocks. 2019 saw a 29% return on the S&P 500, its best year since 2013. Every stock sector ended in positive territory. Anyone could have been made to look smart in a market that performed so favourably. And yet for much of the last year, the rally was a low conviction one. Many retail investors sat on the sidelines, missing out on much of the performance. They worried about market valuations, corporate earnings growth and the impact of the trade war. Yet, the market still edged higher on lower volumes, corporate share buybacks and investors buying on dips. Even the unpredictability of President Trump, and his ability to shift the market tone through a tweet, failed to consistently destabilise. But the spectacular market performance hasn’t removed the risks. The recent Q4 corporate results showed signs of life in earnings growth. However, growth rates, while recovering, still remain lacklustre. For the reporting season, S&P 500 companies have increased profits 1.2%. Yet analyst expectations for the full year, currently at around 8%, look overly optimistic. Weaker demand, disrupted supply chains and lower confidence are all likely to result from the COVID-19 outbreak. Apple’s recent coronavirus-related revenue warning is a sign of what could still be to come. Still, investors have come to the conclusion that staying out of the market has not worked as an investment strategy, and it remains a challenge to generate above-inflation returns via other asset classes. Given the low bond yield environment, US Treasuries have even less appeal than they would otherwise for the average investors. One of the reasons for the stock market’s continued performance is the excess availability of capital. Last year’s interest rate cuts by the US Federal Reserve helped reassure investors that the stimulus was in place to ensure that US economic growth can continue. China’s government has also been pumping billions of dollars into its economy, over spilling into other stock markets. Monetary policy injections are helping to soothe stock markets and provide confidence for investors. There’s a complacency that central banks will step in if need be. A key driver of market performance has been continued strength in technology stocks, notably large cap names. Technology giants Apple, Alphabet, Amazon and Microsoft have all grown into $1trn market cap companies. They have become a go-to for fund flows, as investors buy into the idea they are all exposed to exciting long-term structural growth stories, such as cloud computing, digital transformation and streaming. Combined they also account for more than 17% of the S&P 500. As a result, this narrow band of names now has a disproportionate impact on the wider market’s performance. The lack of breadth driving the wider market’s performance poses a risk if and when market sentiment turns. Once again, Apple’s revenue warning poses questions. Markets are also vulnerable to economic shocks when they are expensive. The S&P 500 trades on a price-to-earnings (P/E) ratio of 20x. In comparison, the market’s long-term average of 16x, making the current market valuation picture look at its most stretched in several years. This could particularly become an issue in coming months. As already suggested, corporate earnings estimates for the next few quarters are yet to fully adjust to the impact of the coronavirus. So, investors can cheer for the fact that the US market’s early year performance has been encouraging. But, given the known risks, it’s dangerous to assume that the market will continue to advance in a predictable, linear fashion. Investors beware.
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