Can anything halt the rise and rise of US shares?
15 Sep, 2021
By Cherry Reynard
The US market seems to be Teflon-coated. The pandemic has seen barely a dent in the long-term rise of the S&P 500. It has shrugged off higher inflation. Even the sky-high valuations can be shrugged off as long as revenues keep rising. Can anything halt the rise and rise of US shares?
The performance of the US market has been truly astonishing. The S&P 500 has almost doubled from its pandemic lows in March 2020, rising from 2,304 to 4,458. Even ignoring this shock, the index is 1,300 higher than it was at the start of 2020. It has defied almost every problem that has been thrown at it over the past year and emerged triumphant.
What explains the relentless success of the US stock market? Much of the strong performance can be pinned on a handful of stocks: unsurprisingly, these are Apple, Microsoft, Facebook, Amazon and Google-owner, Alphabet. These are the largest holdings in the S&P 500, with the information technology sector making up a chunky 28% of the overall index.
Their importance to overall returns in the US index can be shown by the relatively weaker performance of the Dow Jones, which focuses on industrial names and therefore doesn’t include many of these businesses. It has a three year annualised return of 13% versus more than 18% for the S&P. The S&P returned almost double the Dow Jones in 2020.
Technology has been a notable beneficiary of the pandemic, which accelerated technology adoption in areas such as ecommerce, company digitisation and cloud computing. This has helped technology companies to keep delivering higher earnings.
The US market is dominated by technology stocks, which continue to show extraordinary levels of growth and profits, often ahead of market expectations. Changes to the way we work and communicate are still creating huge opportunities in the technology sector and US companies remain at the forefront of this. This has justified the high valuations
The Dollar has also played a role in the strength of the US market. The Dollar strengthened against most major currencies in the latter part of 2020. It was considered a safe haven in the wake of the pandemic. This helped inflate the value of US assets for international investors. The Dollar has been weaker in 2021, but only marginally.
There is a final consideration: US policymakers have spent eye-popping amounts to shore up the US economy and keep growth motoring. There are the Covid handouts, the $1,400 cheques that have been handed to millions of US citizens, the multi-trillion Dollar infrastructure package and, of course, the low rates and quantitative easing packages that have continued to support the economy.
With this in mind, the US market could be undone by a reversal in any one of these factors. In particular, a reversal in monetary policy could have a savage impact on the US stock market. At the recent Jackson Hole meeting, the Federal Reserve made it clear that it would start to taper its quantitative easing programme by 2021. This has almost never happened without drama. The 2013 ‘taper tantrum’, for example, saw bond yields spike and markets sell off.
While the Federal Reserve has made it clear that any tapering will be done slowly and with a clear eye on the data, it could produce volatility, particularly in the US. This may disproportionately affect the technology sector. While interest rates are low, the high growth rates of technology companies are particularly prized by investors. If interest rate expectations rise, the lofty valuation of high growth technology companies may be reappraised by investors. Technology companies could see their share prices fall, even though revenues and profits continue to grow.
The correlation between US treasuries and the Amazon share price has been significantly positive and that has increased in the last few months. This suggests it may not look very pretty if interest rates go up.
As such, the direction of Inflation is important. This will determine the speed of Fed easing. CPI inflation reached 5.4% in June and has remained high. The Fed continues to believe inflation is transitory, but there are supply bottlenecks and signs of wage growth. This may ultimately be tempered by the longer-term deflationary effects of rising demographics and the impact of technology. However, inflation needs to start falling soon, otherwise the Federal Reserve’s claims that it is short term will start to look hollow.
It has usually been wrong to bet against the US market. US companies are dynamic, well-run and profitable. There are plenty of investors in the US market, which help price discovery. Certainly, valuations are high, but the country always trades at a premium to its peers. However, the normalisation of interest policy presents a key challenge, which may yet unnerve the US market.
