A possible trade war between the world’s largest economies, the United States and China, reared its head again this week, and instead of shirking at the crippling impact on American businesses, US stock markets streaked to record highs.
Reports the White House planned to impose tariffs on Chinese imports and revoke some Chinese companies’ licenses to sell products in the US theoretically should have had financial markets reacting in horror.
The prospect of curbing the free flow of commerce between the world’s largest economies would have widespread implications for American-listed enterprises, limiting growth and adding layers of regulation around existing partnerships.
The response? Stocks on Wall Street rocketed to record highs; the Dow Jones smashed through 22,000 points for the first time in its history and President Donald Trump was quick to claim the victory.
“Today the stock market hit the highest level that it has ever been and our country is doing very well,” the President announced on Twitter.
Hefty corporate earnings results these last few weeks have buoyed investor sentiment, with earnings growth for the S&P 500 on track to clock a healthy 9.7 per cent year-over-year for the second quarter, according to FactSet.
This follows a 15 per cent surge in the March quarter.
Earnings from the likes of Boeing, McDonald’s, Apple and American banks have done the vast majority of the heavy lifting, their sheer size making them primary drivers of the Dow Jones’ recent highs. Corporate earnings
While the US president has lauded the performance of American companies as a direct result of his capable leadership, most experts point to an improving global economic picture as being more significant.
A combination of low inflation and rising global growth could keep US stocks climbing and this reporting season, technology stocks and financials have largely given investors cause to cheer.
“It’s been a strong earnings season with large corporates delivering good, organic growth,” said Peter Wilmshurst, global equities portfolio manager at Franklin Templeton.
“The names we hold, particularly the technology names, have delivered good results.”
The largest public companies have seen profits accelerate in 2017, with earnings rising at a double-digit pace compared to 12 months ago, according to data by Thompson Reuters.
For some investors, the latest milestone helps allay concerns about the longevity of a bull market that began in March 2009.
This sharemarket cycle has been marked by a string of new breakthroughs: the Dow shattered 20,000 in January following its 15,000-marker in 2013. (It first topped 10,000 in 1999.)
But while the picture of a US economy roaring back to life after one of the most severe financial crises in living memory certainly has boosted the animal spirits of investors, many fund managers are wary of just how expensive US equities are.
“While stocks are not near the valuation bubbles we’ve seen in the past, it’s definitely true the US is probably one of the most expensive markets in the world,” says Wilmshurst. Pricey tech stocks, lagging industrials
Technology stocks – the likes of Facebook, Amazon, Netflix and Microsoft – have driven much of the gains in the S&P 500 this year but the appetite for the innovation and growth potential of these companies might have pushed them into the “seriously overvalued” category.
“We are very cautious on US technology companies from a valuation point of view,” says Jordan Cvetanovski, portfolio manager at of Pengana Capital’s international equities fund, which was holding the maximum amount of technology stocks it could two years ago, but since then has halved that.
“We think these companies have become so expensive that we’re initiating some protection on the Nasdaq and buying some put options.”
Additionally, the uneven spread of company performance is a warning signal to some that the US bull market might be unsustainable.
Looking at the industrial stocks within the Dow Jones Index, which are fetching record prices, theoretically the Dow Transportation Average should also be heading towards record territory.
But instead, the index is lagging those overachieving Dow industrial companies, like Boeing, by almost 10 percentage points.
“The market gain has been built on a narrow group of issues. That typically is not indicative of great health,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott.
“I would not be shocked if we saw a pullback.” End of the Trump trade
Despite the abstract way that President Trump uses his Twitter account, it is difficult to deny shares have definitely performed better under his administration.
The “Trump trade” has seen investors pour into equities the world over, jubilant at the prospect of lower company taxes and other reform, sending Wall Street and the FTSE to record highs and reigniting speculation the ASX will hit 6000 points this year.
Since the inauguration on January 20, the 30-stock Dow Jones is up 11 per cent and the broader S&P 500 is 8.7 per cent higher.
But the inertia of Congress and the lack any policy detail has seen this particular motivation for positive investor sentiment deteriorate.
“People were betting on his ability to get things done,” said Pengana’s Mr Cvetanovski. “And the next thing people are focusing on is whether the corporate tax cuts will get through.”
During the week, President Trump tweeted: “Corporations have NEVER made as much money as they are making now”, which many interpreted as the launch of the next Republican priority, after the failure to repeal Obamacare.
While it’s unclear exactly what the tax cuts would look like, many are wary of how successful the administration will be.
“It’s hard to have conviction that they’ll achieve what they want to do,” said Franklin Templeton’s Mr Wilmshurst.
“While this Trump administration has a softer regulatory touch which has been good for the likes of financials, there’s no plan for what the corporate tax might look like.”
Regardless of what the administration may or may not do, investors have taken heart at recent economic data signalling a pickup in the underlying economy.
US manufacturing data remains solid, with factories still expanding and the Purchasing Managers Index rose from 52 in June to 53.3 in July. Vehicles sales are rising and while construction spending is in a clear downward trend, the economy is nearing full employment.
While short-term market sentiment has lowered expectations of another Federal Reserve hike, a trifecta of healthy job creation, buoyant wage growth and a larger number of Americans re-entering the workforce is likely to keep the central bank tightening monetary policy. ETFs
But the outperformance of US equities overall has some international fund managers shaking their heads, saying the bullish fervour gripping investors is a misguided result of distorted capital markets.
No longer punch-drunk on President Trump’s pro-growth policies, shares are artificially boosted by swollen passive ETF trades and the headline-grabbing earnings growth is only visible in pockets of the US market.
“There is no scalpel dissecting what companies are good and which are bad,” said Mr Cvetanovski. “There is so much widespread ETF buying that distorts entire sectors.
“This is just another way of making something that’s artificially expensive, even more expensive.”