Prophets

The Daily Prophet: This Rally in Stocks Has to End, Right?

Connecting the dots in global markets.

Maybe it's time to start believing in the stock market. The Dow Jones Industrial Average is now up 15 percent since the U.S. election, rising above 20,000 in late January for the first time and blowing through 21,000 today in its biggest gain of the year. The S&P 500, Nasdaq Composite Index and Russell 2000 also closed at record highs. 

Cynics say this is built on little more than hope that the Trump administration can deliver on its plan to cut taxes, reduce regulations and spend big on infrastructure. Sure, some of that is built into prices, but there's no denying that global fundamentals are strengthening. U.S. manufacturing expanded in February at the fastest pace since August 2014. Euro-area manufacturing accelerated for a sixth month. An index tracking Chinese manufacturing held at some of its highest levels since 2012. While the U.S. gets the headlines, the rally is a worldwide phenomenon. An MSCI index of stocks that excludes U.S. equities is up 9.30 percent since late November.



At almost eight years, the current bull market in U.S. stocks is the second-longest on record, but they don't die of old age. It often takes a recession, and not one of the more than 80 economists surveyed by Bloomberg News sees that happening this year or next. "We are now into what we would all agree is implementation risk -- what can Congress and Trump get done and how long does that take and what is the sequencing of those events?'' Neil Dwane, a global strategist at Allianz Global Investors, said Wednesday in an interview on Bloomberg Television.

JUNK BONDS
It's not just stocks. A key area of the debt market is also flashing an up arrow when it comes to the outlook for the U.S. and global economy. In fact, the best performing bonds this year are those rated below investment grade, or junk. The securities have gained 3.12 percent this year through yesterday, according to the Bloomberg Barclays Global High Yield Index. Investors are accepting yields that are less than 4 percentage points above Treasuries to buy the debt, versus almost 9 percentage points a year ago. Corporate profits are rising after years of being depressed. With the earnings season drawing to a close, about three-quarters of S&P 500 members that have reported results beat profit estimates and a little more than half exceeded sales forecasts, according to data compiled by Bloomberg.



FED ODDS
One way to interpret the strength in stocks and junk bonds is that the market believes that the economy is finally strong enough to withstand multiple interest-rate increases from the Federal Reserve. Today's rally came even as the odds of a hike coming this month soared to above 80 percent. That's notable because, according to Bianco Research, the market is never wrong when predicting the Fed’s actions this close to a meeting. Once a meeting is only 10 trading days away, which is currently the case with the next conclave scheduled for March 15, the market has correctly predicted the Fed’s actions 90 of the last 90 times. That's a pretty good track record.



YIELD CURVE
Nonetheless, a case could be made that with inflation still tame, the Fed can afford to hold off on raising rates this month. The market for U.S. Treasuries is certainly signaling that inflation is not in jeopardy of accelerating too fast. That can be seen in the gap between 2- and 30-year Treasury yields. The so-called yield curve is the narrowest in four months after short-term rates rose while long-term rates held steady. If traders really believed inflation was about to take off, then long-term bonds would tend to underperform. That's because inflation erodes the value of fixed payments over time, so the more payments you have coming, the more you are at risk of losing purchasing power.



CONSUMER CONCERNS
There is one (potentially very big) area of concern. Consumer spending, which accounts for 70 percent of the economy, slowed in January, according to a Commerce Department report Wednesday. After adjusting for inflation,  spending fell 0.3 percent after a 0.3 percent increase in December. The decline was the biggest since September 2009. Economists lowered their estimates of first-quarter growth following the data, which is at odds with rising consumer and corporate confidence.



TEA LEAVES
Over the next couple of days, markets will be listening closely to a parade of Fed officials for clues as to whether they have already decided to raise rates in two weeks. Fed Governor Lael Brainard will soon speak about the economy and monetary policy at the John F. Kennedy School of Government. Brainard has a dovish inclination, according to Bloomberg Intelligence economists. Fed Chair Janet Yellen and Vice Chairman Stanley Fischer are due to speak at separate events on Friday.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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