- The US interest rate has dropped to an all-time low of 0.1 per cent
- There’s the prospect, albeit not guaranteed, of massive fiscal stimulus under the incoming administration
When Donald Trump was sworn in as US president in January 2017, the federal funds rate was 0.65 per cent, US-based corporations paid a 35 per cent tax rate, and the market value of the S&P 500 was just below $20tn.
Four years, two Americas and one horrific pandemic later, the US interest rate has dropped to an all-time low of 0.1 per cent, after peaking at a post-financial crisis high of 2.4 per cent in July. Following the Tax Cuts and Jobs Act of 2017 – perhaps the single most important market-moving policy of the Trump administration – companies now hand just 21 per cent of their income to the government. That cut goes some way to explaining the surge in the S&P’s value to more than $30tn. But it doesn’t completely explain why the country’s largest financial market has grown by more than half in a period when gross domestic product (GDP) looks set to rise by just 4 per cent, once the pandemic’s knocks to output in 2020 are factored in.
Investors need to look at three pieces of evidence as to why. First, there is the step up in the market’s valuation – from around 17 to 22 times next year’s earnings – a product of the dominance of US tech stocks, whose success has seen them command sky-high valuations and an ever-greater share of the S&P’s market capitalisation.
How much further this bidding war for future corporate earnings can go remains a central question for anyone who holds a generic index-hugging tracker fund in 2021.
Then there’s the prospect, albeit not guaranteed, of massive fiscal stimulus under the incoming administration. This could light a fire under an economy still far from capacity. Throw in rapid vaccine roll-out and those great expectations for earnings look slightly less fanciful. The forward yield curve in US Treasuries – the yield premium in 10-year notes relative to their two-year equivalents – is now at its highest since October 2017, suggesting bond investors expect inflation, economic growth, or a combination of both.
Lastly, there is sentiment, and the powerful feeling that all alternatives to US equities are ultimately second-class. Although a volatile election cycle prompted fresh talk of an America in decline, the country’s pandemic response also underlined the fact that in times of acute market stress, investors are prepared to pay up for dollars. One of the greatest strengths of the American economy – an ability to fund itself cheaply – is not going away.
Neither is the dollar’s status as the world’s reserve currency, even if the headwinds are growing. And so long as individuals want dollars, then it need not matter too much if the greenback has fallen 11 per cent since this year’s money-printing programmes by the Federal Reserve. In theory, it will only make American goods more attractive to overseas buyers, a dynamic long sought by Mr Trump.
Over to Joe
Ironically, any trade benefit of a weaker dollar could fall to the White House’s next occupant come January. The post-Trump era will certainly be different – fewer (if any) late-night Twitter outbursts and a more measured approach to policy making. But the next four years will not simply be a return to ‘business as usual’.
Joe Biden faces the task of healing a country that is not only deeply divided but has also been ravaged by Covid-19. With Capitol Hill arguably more partisan than it has ever been, getting the US economy back on track will be no easy task.
Biden faces tough choices
Regardless of any stimulus cheque Americans receive in their Christmas stocking, President-elect Biden has said that “any package passed in the lame duck session is not enough. It’s just the start.” But the level of relief handed out in the new year – alongside much of the incoming president’s agenda – will depend on whether Democrats win the two run-off races in Georgia in January and regain control of the Senate. For the past five years, Washington has been the fiefdom of Senate Majority Leader Mitch McConnell and should Republicans retain the Senate, Biden’s Rooseveltian spending plans would be dead on arrival.
Wall Street likes the idea of a divided government as it lowers the risk of corporate tax increases. But the ambitions of a Biden administration could be curtailed even in a best-case scenario of a 50:50 Senate outcome where the vice-president breaks the tie. More moderate Democrats could prove resistant to sweeping change.
Without full control of the legislative branch, the executive wing can still increase regulation. If confirmed as treasury secretary, Janet Yellen could oversee tougher rules for the financial sector as well as a more predictable approach to international trade. The US-China trade war is a major legacy of the Trump era, but don’t count on a complete about-turn. Mr Biden has said he will not immediately remove tariffs on Chinese imports or tear up the Phase 1 trade agreement. While he has promised to pursue policies that “actually produce progress on China’s abusive practices”, there are few details at present. That said, his chosen path is likely to be less damaging to investors’ portfolios. The New York Federal Reserve estimates that the trade war has wiped $1.7tn from the market caps of US-listed companies. That said, looking at the trajectory of US markets this year, trade war concerns appear to have been long forgotten.
Overheating markets and a cooling economy?
US indices have been surging upwards since mid-March, reaching record highs. But the stock market is looking increasingly detached from economic reality. True, more than half of the 22m jobs lost at the start of the pandemic have been recovered and November marked the seventh consecutive month of jobs growth. But momentum is slowing, with employers adding net 245,000 jobs last month, down from 610,000 in October. Potentially signalling more lasting damage, the number of people who have been out of work for at least 27 weeks – which is considered a barometer for long-term unemployment – grew by 385,000 in November, equivalent to 37 per cent of all unemployed workers. This is rapidly approaching the 45 per cent peak seen in 2010 following the global financial crisis.
So, why is the stock market still climbing? “On the surface, it’s understandable why stock prices have been soaring over the past month,” says Robert Doll, chief equity strategist at asset manager Nuveen. “The good news on the vaccine portends economic normalisation next year, the US election produced no major surprises, monetary policy should remain hyper-accommodative, fiscal support should continue and negative real rates for government bonds are supportive for risk assets.”
But that must be set against rising Covid cases in the near-term and parts of the country shutting down again. Even with a vaccine, the recovery is a marathon and not a sprint. While President-elect Biden aims to vaccinate 100m Americans in his first 100 days in office, at least 75 per cent of the population needs to be inoculated to achieve herd immunity. That’s no simple task given storage and distribution issues and uncertainty over whether people will choose to be vaccinated. We also don’t yet know how long a vaccine will be effective for.
Still, the bulls are focused on the light at the end of the tunnel. The economy is seen as a coiled spring that will snap back into action next year, producing the vaunted V-shaped recovery. Indeed, Morgan Stanley predicts that a 3.5 per cent contraction in GDP this year will be followed by 5.9 per cent growth in 2021. Mr Doll believes that “beyond a period of uncertainty over the next few months, the outlook for stocks is brighter in 2021”.
