This has been a great year for US stocks. The S&P 500 index is up by over 13 per cent so far in 2020. Until last week, the market has been on a run of making all-time highs on consecutive days. This year some sectors, such as technology, have been red hot – even the unloved value sector has seen some renewed interest.
At face value this ebullient stock market seems incompatible with the reality of a US economy that has seen its greatest public health crisis of all times and lost 11 million jobs, with many sectors simply shut down, stalling fiscal support and 300,000 deaths due to the virus.
After the initial drop in February and March, the market recovered mainly on optimism around policy support both from the government and the US Federal Reserve. Then we began to see early and solid rebounds in the jobs market and forward-looking business confidence indicators.
The stock market has been touted by President Donald Trump as the true indicator of what he has done for the US economy. The supporting argument for a continuing healthy stock market centres around a positive view on the economy for 2021 – consensus is now that the US economy can see a growth rate next year of around 4 or 5 per cent. This, in turn, is based on a conviction of better medical numbers, the re-opening of the economy and a widespread and successful roll-out of vaccines early in 2021. Goldman Sachs, for example, forecast for 200 million people to be vaccinated by the end of September 2021.
The resulting picture for corporate profits growth is that investors will be looking at a growth rate of 20 per cent for 2021 earnings compared to 2020. This positive narrative has driven the stock market to quite an elevated valuation. On a forward-looking basis, US stocks are trading on about 21 times next year’s earnings.
There is not a lot of room for disappointment. Not only is the market valuation stretched, however, investor positioning in US stocks is also quite stretched today. Institutional investors as well as hedge funds are holding as much exposure to the US stock market as they ever have done over the past 30 years.
Households and institutions are “fully invested” in the market. And admittedly it has been the right call for 2020. Stretched investor positioning is not by itself a catalyst for a weaker stock market. But when accompanied by a stable or deteriorating economic environment, it has proved a headwind for investors.
So the near-term prospects for the US economy take on added importance. The numbers being reported on cases, hospitalisations and deaths in the US are very worrisome. The mantra from the public health experts is “worse before it gets better”. Any policy response to the continuing pandemic in the US is likely to impact on fourth-quarter growth. We have already seen a rolling over in economic growth through November. The US economy added only 245,000 new jobs in November, about half of what was expected and well shy of the millions added between May and July.
Business confidence numbers, especially among smaller firms, have also peaked and many companies talk of shut-downs and absenteeism due to Covid. The US economy since the end of September has been drifting back towards lockdown, though nowhere near the nadir of last March.
The trend is also visible in higher frequency data. Table bookings in restaurants have slipped back. Electricity usage has fallen. Also consumers say they aim to have most of their shopping completed earlier than usual, suggesting a quiet end to the month of December.
Momentum in the US economy is, perhaps, best summed up by an index of economic surprise produced by Citigroup. While still positive, this barometer of whether economic data is better or worse than expected is 80 per cent below its peak at the end of June. The experience on Wall Street is very different from the evidence on Main Street. Against a deteriorating backdrop, we have a market that is over-valued and over-owned. For the stock-market to continue at this pace and in this direction needs an awful lot to go right.
Eugene Kiernan is an independent investment strategist and is president of the Chartered Institute for Securities and Investment