How to judge whether there is any remaining upside Stateside

In the interests of the sanity and eyeballs of both the author and its regular reader(s) this column is going to make a concerted effort to be much shorter in future (even if previous ones were designed so that time-pressed advisers only needed to read the first section to get the full gist).

This week, we shall investigate the US financial markets and how one table and four charts (with just a smattering of commentary) suggest that advisers and clients with substantial exposure to trans-Atlantic exposure may need to at proceed with caution after a stunning bull run.

  • First, it is noticeable how the US government bond market and the dollar are a lot less convinced by the ‘Trump trade’ and the President’s plans to stimulate economic growth Stateside than is the stock market.

    Since Trump’s election, stocks have advanced smartly but bond yields are hardly changed and the dollar has actually weakened, despite two interest rate increases from the Federal Reserve.

    This is not to say these trends are mutually exclusive but experts in different areas are taking a different view, with equity investors apparently much more optimistic.

    US bond and currency markets seem less upbeat than America’s stock market

    (*Based on DXY trade-weighted basket)
    Source: Thomson Reuters Datastream.

  • Second, this bond market scepticism becomes even clearer upon study of the yield curve – the interest rate available on US Government bonds of differing maturities.

    A steepening curve usually suggests advisers and clients believe stronger growth and higher interest rates are on the way. A flattening one is usually indicative of an economic slowdown ahead – which is odd as the US Federal Reserve is currently increasing interest rates anyway, raising the risk of a policy error and tighter monetary policy when the economy is vulnerable.

    This next chart shows how the curve has flattened by showing the premium on the ten-year US Treasury (Government bond) relative to the two-year.

    The US yield curve is (still) flattening

    Source: Thomson Reuters Datastream

  • Third, even share-buyers have become less gung-ho if the broad S&P 500 is any guide and even the tech-laden NASDAQ is looking a bit wobblier, as this column discussed two weeks ago and this chart of the London-listed PowerShares EQQQ NASDAQ 100 Exchange-Traded Fund (ETF) suggests. Holders of the tech-index tracker will be hoping it can quickly bounce back to new highs as the alternative could be a sharp pull-back, at least from a technical (chart-based) viewpoint.

    Even the red-hot NASDAQ tracker is losing a little steam

    Source: Thomson Reuters Datastream

  • Fourth, trading volumes in the S&P’s constituents have begun to quieten down. This could be down to the summer (and the imminent public holiday on 4 July) or it could be the harbinger of deteriorating technicals for the US market – markets that rise on low volumes tend to lack conviction and be prone to reversals, especially if breadth is narrow and a relatively select number of stocks is leading the indices higher (as has been the case this year with Facebook, Amazon, Alphabet, Netflix, Microsoft and a couple of others).

    Dealing volumes in S&P 500 stocks have begun to sag

    Source: Thomson Reuters Datastream

  • Such concerns do not mean the US stock market is poised to collapse, as it did in 2000-03 or 2007-08. But it may mean advisers and clients should assess portfolio weightings and exposures to make sure they remain comfortable.

    The long-awaited increase in volatility may be just around the corner, especially as returns have been so good.

    This final graphic shows the 10-year compound annual return from US stocks from the S&P 500 index.
  • While the past is no guide to the future, history suggests that real ‘buy’ signals come when 10-year compound returns have ebbed to zero (or below). The last decade’s 5% compound return looks justifiable assuming trend GDP growth of 2-3% and inflation of the same but since the Fed and the new President are having trouble sustaining those numbers, let alone accelerating them, further proof that the ‘Trump trade’ is working may be needed to take US stocks markedly higher from here.

    10-year compound returns from US stocks do not suggest they are compellingly cheap (if history is any guide)

    Source: Thomson Reuters Datastream

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.