It seems a long time ago but it was only in April that markets had a sharp correction thanks to Trump’s threats of tariffs. As concerns about these tariffs have eased, stocks have come roaring back.
It hasn’t just been a tariffs story. Economies have held up ok and inflation has continued to trend down. There’s also been significant stimulus announced in Europe, and to a lesser degree, in China.
Yet, one of the biggest drivers behind the recovery in stocks has been the expectation that interest rates will fall further and faster. That’s because Trump wants rates in the US much lower, and once he gets his own Federal Reserve Chairman appointed (by May next year at the latest), that will undoubtedly happen.
In essence, markets are frontrunning lower US rates and possible quantitative easing. Cheap and easy money is coming, and they can’t get enough of it.
13 charts highlighting the speculative frenzy
Here are some indicators of the recent exuberant risk-seeking behavior in markets:
1. Trading in expensive and penny US stocks is near record highs
2. Leveraged bets on markets going up have soared
3. US stocks with elevated short interest have surged
4. Recent IPOs have generated strong first-day returns
5. Special purpose acquisitive vehicles (SPACs) are back in vogue
These vehicles raise capital to acquire existing operating companies. Investors essentially give black cheques to SPACs to make acquisitions.
SPACs have raised US$12 billion this year. That’s nowhere near the heady days of 2021, though it’s still a lot of money.
6. Cryptocurrency prices are flying
Prices of Ethereum and bitcoin have catapulted higher, helped by the Trump administration’s pro-crypto policies and growing acceptance by mainstream financial institutions.
7. Meme stocks are again a thing
You might remember that in 2021, retail day traders drove US mall retailer GameStop and other so-called meme stocks to ridiculous prices.
Well, meme stocks are back. This time it’s in companies such as Kohl’s and Opendoor. The latter is an online house flipper and its stock is up 377% in the past month.
8. Retail investors have been big buyers of the rally, while institutions have been sellers
There was a similar rise in US retail investor money in 2021.
9. The equity risk premium for the S&P 500 is near zero, the lowest since 2001
The equity risk premium measures the S&P 500’s earnings yield (earnings divided by price) versus the US 10-year bond yield. It’s an indicator of valuations of stocks compared to risk-free bonds.
10. It’s not just stocks – credit has also found favour
Spreads on US investment-grade corporate bonds are near the tightest levels since the late 1990s.
"The theoretical minimum spread is lower today. High-quality corporate credit can now trade closer to, or in some cases even through, US Treasuries in a way that was not previously conceivable”, says Citigroup.
11. There’s been some speculation in ASX stocks too
It hasn’t been to the same degree as in the US, but the likes of CBA and Pro Medicus saw extraordinary gains in the first half of the year.
12. Valuations on the ASX 200 are now punchier than 2021
Source: Betashares
13. The equity risk premium for the ASX 200 also implies expensive valuations for stocks
Source: Betashares
Are we headed for a fall?
Are we careering towards another 2022 market reality check?
Extrapolation from recent history is a dangerous business because no two periods are ever the same. For instance, back then, the world and Australia had a serious inflation problem. Our inflation rate went from -0.3% in June 2020 to peak at 7.8% in the December quarter of 2022. That led interest rates to rise from 0.1% in April 2022 to 4.35% in November 2023.
Now it’s different because inflation is falling here and in the US. And interest rates are on the way down, not up.
We also have a US President that is committed to getting rates lower and keeping them there.
There are other differences between today and 2021-2022 too. Back then, China was still locked down. Now, China’s economy remains in the doldrums though there are at least some tentative signs that the worst of its property-led slowdown may be behind it.
And Europe has dramatically changed since Trump came into power earlier this year. Germany has reversed decades-long government debt restrictions with plans to spend tens of billions on infrastructure and defence. If EU members increase their defence budgets by 1.5% of GDP as suggested, Joachim Klement estimates that those measures in aggregate could raise the EU’s annual trend growth rate over the next 10 years from 1.6%, the current OECD estimate, to levels like the 2.1% projected for the U.S.
We also have this new thing called AI that is already leading to massive spending from US tech giants and could spur economic productivity gains in the US and elsewhere.
All of this suggests that the current rally could run further. The risk is that Trump overheats the US economy, resulting in a rebound in inflation and rates heading back up.
Markets aren’t looking that far ahead, and for now, it’s risk-on.
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On the subject of investor exuberance, what does history tell us about the performance of markets once they reach record highs? Schroders' Duncan Lamont combs through 100 years of data to give us the answer.
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In my article this week, as interest rates fall, it's becoming harder to find decent, sustainable sources of income. I look at the best places to hunt for yield.
James Gruber
Also in this week's edition...
Recently, the UK's Chancellor of the Exchequer, Rachel Reeves, was in tears in Parliament after her Prime Minister shelved a plan to cut disability payments. The bond market erupted as it raised the prospect of the government hiking taxes or issuing more debt to fund its welfare system. Clime's Paul Zwi recounts these events and asks if Australia risks a similar backlash if it doesn't soon address ballooning NDIS spending?
Ashley Owen is back with a fantastic piece on Chinese steel production - both its incredible feats and how much it has contributed to Australian incomes and wealth. The big question for us is whether that steel production is in danger of falling both in the short and longer terms. Ashley offers a positive take on the issue.
There's a lot of hype in the tech world about stablecoins and their potential to provide an easy and cheap way to make cross-border payments. If right, it would be bearish for payment processing giants like Visa and Mastercard. However, Magellan's Elisa Di Marco believes stablecoins have a long way to go before they can be considered as a genuine disruptor.
Is there a theme that offers assured growth for the next 30 years? It's a tough question to answer, though Sarah Shaw thinks infrastructure comes close. She outlines five tailwinds for infrastructure that make it a compelling investment.
The markets have had a volatile six months, gyrating around news about Trump, tariffs, debt ceilings, wars, bond market ructions, and the list goes on. How do you keep your head in times like this? Michael Bogoevski has taken a step back to write a note he wished he’d received earlier in his investing journey - a guide for navigating the narratives and noise.
Finally, in this week's whitepaper, Vanguard says too few people are putting their savings to work in the financial markets, potentially reducing their long-term returns. It suggests redesigning retail investment systems to encourage more people to invest.
Curated by James Gruber and Leisa Bell
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