The US bull market continues to lift appetite for global stocks
The month of March marked the 10-year anniversary of the US equity bull market. Since 9 March 2009, when the S&P 500 benchmark index troughed at a devilish 666, US stocks have gained 16% per year, more than any major market – see the top right chart in the market highlights. From our calculations, roughly two-thirds of those annualised price gains have been driven by company earnings per share (EPS), suggesting that the market rally is fundamentally supported and can be sustained. While EPS data has been distorted by share buybacks, the impact is small. For instance, JP Morgan estimates that net buybacks have contributed to only 2% of operating EPS per year on average over the past decade.
Moreover, the underlying US economy currently does not exhibit typical signs of excesses and imbalances that could undermine the business cycle. First, US household and corporate combined savings, a measure of the difference between private sector incomes less spending, was in a 4.2% of GDP surplus versus deficits of -4.4% in Q3’00 and -2.7% in Q3’06. In other words, unlike the last two occasions, this expansion has not been driven by unsustainable credit to finance growth. Second, inflation and labour costs remain fairly muted, implying limited signs of economic overheating. And third, though corporate debt has gradually been building up, balance sheets are sufficiently healthy to absorb higher financing costs. While economists tend to look at debt to domestic GDP ratios, it may make more sense to compare debt to assets for internationally- focused companies. On that basis, the US corporate debt to asset ratio stands at 21.6%, below the historical peak of 25.6% in the 1990s and is only slightly above the historical average of 20.8%. Moreover, interest costs are contained. JPMorgan calculates that interest costs for listed US stocks currently account for an historical low 18% share of company earnings. However, one risk is that should the economy slow down, companies’ access to capital markets may become restricted. We therefore continue to monitor financial conditions. Overall, it is reasonable to expect the rally in the American stock market to be extended and lift other regional markets higher.
Risks from Fed monetary tightening have been lowered
With easing financial markets conditions and the US unemployment rate reaching its lowest level since the late 1960s, there is a risk that the Fed may surprise markets and turn more hawkish on US interest rates again. Nevertheless, considering that underlying inflation remains contained and the interest rate projections from the latest Federal Open Market Committee (FOMC) meeting predicts no rate hikes this year, it appears that is a low risk probability. Most important, investors are arguably now assured that Fed Chair Powell stands behind the market, similar to previous incumbents like Ben Bernanke, Janet Yellen and Alan Greenspan. In short, this so called “Powell put” should boost investor confidence.
Rising US-Chinese geopolitical tensions over Made in China 2025 and technology competitiveness
Market volatility continues to fluctuate on whether President Trump decides to step-up import tariffs, as part of the US trade spat with China. However, with the 2020 presidential election campaign heating up, President Trump is likely to agree a deal with China to avoid a damaging trade war that could hurt his base supporters and hinder his chances of re-election.
Nevertheless, geopolitical tensions between the two superpowers are simmering beneath the surface over Made in China 2025, a flagship Beijing policy to make the country’s manufacturing base become more hi-tech. Currently, the specific issue that the US and China are fighting over is who has supremacy in 5G telecommunications, a key technology to handle the explosive growth in global data generation from the Internet of Things (or IoT - devices that can communicate and interact with others over the internet, such as smart traffic control sensors).
China has significant cost advantages in 5G technology. For example, China is forecast to have 430 million 5G subscribers by 2025, larger than the entire population of the US. As of last year, China had 350,000 5G-ready base stations, more than ten times as many as the US. This creates economies of scale and lowers the cost- per-user for China’s 5G technology by leveraging on the world’s largest population and infrastructure already in place. Given that US tech companies have capitalised on access to data to boost their market valuations, the 5G revolution provides an opportunity to utilise IoT data to disrupt the balance of power in the tech industry in favour of China over the US.
China’s increasing dominance in 5G technology lies at the heart of the trade spat with the US and underscores why China has a vested interest in protecting its intellectual property. Competition in key technologies will be a source of tension between the US and China over the years ahead, and is a risk for markets.