Despite concerns about slower global growth, the US market enjoyed an outstanding week. Tom Bailey discusses the likelihood of further upside.
In a world supposed to be heading for recession, or at least slower growth, the US market has enjoyed an outstanding week, with the US market topping its all-time high record twice.
On Monday, the S&P 500 closed at 3,039. That new record, however, was soon surpassed again on Wednesday (30 October), when the market closed at 3,046.8.
What's driving the US market to these new highs?
First, the decision by the US Federal Reserve to once again cut interest rates. On Wednesday, the Fed announced the US's key interest rate was being cut by 25 basis points to a 1.50-1.75% range, marking the third such cut this year. Much of the market rally was driven by rate-sensitive stocks.
At the same time, despite the warnings about slower GDP growth globally, the US economy is still performing relatively well. Recent data for quarter-to-quarter US growth came in at 1.9%, higher than the consensus expectation of 1.6%.
As Rupert Thompson, head of research at wealth manager Kingswood, notes:
"These numbers show the US economy remains fairly resilient, with continued strength in consumer spending compensating for weakness in business investment."
Added to that, the US unemployment rate is still at 50-year lows. Tom Rosser, investment research analyst at The Share Centre, describes the US economy as "reasonably robust."
Optimism over a resolution to the trade war has picked up. According to a note form Unigestion's Cross-Asset Solution team: "recent weeks have seen a thawing of relations between the US and China.
"To be clear, we expect trade uncertainty and broad tension between the world's two largest economies to continue for some time. However, currently both sides are showing a willingness to make a deal, even if it is unlikely to be a grand bargain.
"Such an event would be positive for risky assets, as it would reduce to a degree one of the primary sources of uncertainty of the last two years."
How long can it last?
However, the US market still faces potential risks. Pantheon Macroeconomics is concerned about consumer spending being the primary driver behind US economic growth, with manufacturing and business investment remaining weak.
"Consumers are likely to see slower growth in their spending power over the next couple of quarters, as payroll growth slows and inflation rises as a result of tariff pass-through for consumer goods."
Pantheon cites the fact that Walmart (NYSE:WMT) had a net margin of just 2.5%, meaning eventually it and other retailers will have to start passing on the higher tariff costs to US consumers.
At the same time, much of the consumption growth in the third quarter was the result of consumers bringing purchases forward, in anticipation of further tariff rises.
Pantheon Macroecomics notes: The threat of tariffs on consumer goods appears to have boosted third-quarter spending, as people pulled forward purchases in the expectation of higher prices ahead. The announcement of the tariffs boosted third-quarter consumption at the expense of the fourth quarter."
Eoin Maher, a portfolio manager at Unigestion, is also concerned about the ability of consumers to continue to prop up the US economy.
"Consumer spending makes up about 70% of US GDP and it remains to be seen if consumers can maintain their resilience (yesterday the confidence board index came in weaker than expected), in order to continue supporting the broader economy in light of the manufacturing malaise we are witnessing."
Maher also points out that while third-quarter GDP figures were better than expected, "on a year-over-year basis, third-quarter GDP increased 2% during the quarter, the weakest point of Trump's presidency so far, having peaked at 3.2% in the second quarter of 2018."
Markets may also be too optimistic about the prospects of a resolution to the trade war, warns Richard Lynn, managing director at Charles Schwab (NYSE:SCHW). He says:
"Though hope has emanated from anticipated trade talks in October and the delay of the 1 October tariffs, a comprehensive deal remains elusive."
Not everyone, however, is so bearish. According to Kames Global Equity Fund co-manager Mark Peden, the latest rate cut does mean that the US market should continue to hold up for the rest of the year.
The tightening of monetary policy last year ended up spooking markets, leading to the December 2018 sell-off. But, he says:
"The probability of such a situation flaring up again imminently is effectively zero, after the monumental Federal Reserve about-face in late January when it subsequently not only paused further interest rate hikes, but ended up moving to a new easing cycle."
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