Equity market: consolidation phase arguably lies ahead of us

The current upside trend on the equity market, which began in November 2016 with the election of Donald Trump as US president, will not be able to continue at this pace. Since Trump’s election, the Dow Jones and the Nasdaq-100 have both climbed by nearly 50%, the S&P 500 by 40% and the DAX namely by a third. If one extrapolates this price performance (some investors seem to be leaning towards this at the moment), the DAX would be at 18,000 points in a little over a year, the S&P 500 at 4,200 and the Dow Jones at around 40,000 points. Earnings development would not support a price performance of this magnitude.

From a technical perspective, the equity markets are currently in an overheated state that has not been seen for quite some time. With the exception of the leading Swedish share index (OMX 30), all of the 20 largest share indices worldwide are trading well above their 200-day average, namely by an average of 9%. The US indices in particular have outpaced their long-term trend for quite some time. Such a stellar price performance was last seen in 2011, after the “baseline recovery” of the dramatic years in 2008/2009.

Nonetheless, the fundamental starting point for the equity markets is better today compared with 2011. The US economy is leading the posse like a slow-moving tanker. Even though growth is weak compared with earlier recoveries, the US economy has already been expanding for 8 ½ years. This is one of the longest economic recoveries in the country’s history, if not the strongest. The other large economies are growing too, resulting in a synchronised recovery worldwide at present – an event that does not happen very often. With the leading indicators suggesting that many economies are picking up pace rather than slowing down, it does not look as if the economy is going to run out of steam any time soon.

Quite the contrary: The recovery under President Obama was very sluggish and his position vis-a-vis the economy seemed quite indifferent. Accordingly, the volume of public and corporate investment was muted. By contrast, President Trump has presented himself to date as pro enterprise with the attendant sharp rise in economic optimism (even though he can’t take all the credit). This led to a significant increase again in 2017 in the volume of private investment in the US. The tax reform that was recently passed will also generate a positive trend in the enterprises’ profits and new investments, and the option to repatriate assets held abroad will line their wallets even more.

These developments are currently factored in on the equity markets and negative developments that could put the brakes on the market recovery in the long term are being largely ignored. They include political risk factors (e.g. the threat of growing protectionism) but also structural trends (e.g. the foreseeable switch by the Fed from net buyer to net seller of bonds, threat to jobs from automation) and not least the valuation indicators at extreme levels (record low volatility, high equity market valuation etc.) and the resulting prospects of lower yields.

Even though the economic outlook remains very positive, it is only a question of time before we see an imminent consolidation on the equity market. However, Europe would not suffer as much as the US equity market.

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