US equity markets aiming for new all-time highs – Episode 125 of Damien’s Midweek Markets

The 125th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I explain why US equity markets are nearing all-time highs.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 125

In last week’s show, I told you to keep an eye on the US dollar index which you can follow using DX-Y.NYB on your stock app on your phone. I said that if we do start to see the dollar fall then we may reenter a world where equities and bond yields rally at the same time again. If you go back and look at the chart over the last year you can see the ebbs and flows which also coincide with the market’s narrative at the time of whether we were entering a period of reflation or stagflation. This ultimately dictated the assets that won and lost over the subsequent months. 

The early signs of dollar weakness we began to see just before last week’s show continued into this week, with US dollar index falling approximately 1%. While there has been some respite today it’s still a trend to keep an eye on. Part of the reason for the dollar weakness is that traders are now betting other global central banks (including the Bank of England) will raise interest rates before the US Federal Reserve.

With the US dollar weaker, over the last week we have indeed seen equity markets rally alongside bond yields - with the 10 year US treasury yield hitting a high of 1.67%. At the same time, the S&P 500 has rallied strongly and now sits just 0.4% below its all-time high.

Dig below the surface of the S&P 500 and every sector is positive for the week but defensive sectors and those that tend to perform better in a stagflationary environment are lagging those that tend to outperform in an inflationary one. Financial stocks are up 4.3% in a week, while consumer discretionaries are up 4.3%. In contrast, healthcare stocks are up 2.6%, real estate stocks are up 2.1% (both seen as stagflation trades) while the defensive consumer staples are up just 0.3%. Utilities didn’t fare much better. The risk-on sentiment is perhaps best demonstrated by the 5% rally in technology stocks.

When it comes to inflation hedges often the difference between the performance of gold and bitcoin comes down to the prevailing risk sentiment in investment markets. When inflation is rising and investors’ animal spirits are alive and well bitcoin tends to outperform. When rising inflation is met with investor caution then gold tends to perform. In the last week bitcoin has rallied more than 17%, nearing its all-time high, while gold has fallen 0.3%.

Yes, a large part of the rally in bitcoin’s price this week was a result ​​of the first-ever bitcoin futures exchange-traded fund (ETF) in the US making its debut on Tuesday on the New York Stock Exchange with the approval of the US Securities and Exchange Commission.

But taking everything in the round, right now investors optimism has returned and they are buying the recent equity market dip. It will be key to see if the S&P 500 can set a new all-time high in the coming days, as a new-all-time high can only be a bullish sign,

Much of the source of optimism is stemming from the unfolding earnings season. For example an earnings report from consumer goods bellwether Proctor and Gamble that beat market expectations boosted European equities, as it showed that inflation shouldn’t necessarily hurt corporate earnings. If such a trend continues through earnings season then it will likely encourage investors to increase their equity exposure, especially as bonds are still haemorrhaging. In the coming week we will get earnings reports from a host of US tech giants including Facebook, Apple, Alphabet and Microsoft. Will this see the tech-heavy Nasdaq 100 push to a new-all time which it currently sits only 1.5% shy of.

The positive sentiment among investors has gone beyond the US and Europe. The Japanese Nikkei has rallied almost 4% in a week, thanks largely to a weak yen, while Chinese tech stocks are looking like they are trying to find a floor to this year’s rout and have rebounded in recent days. Alibaba shares are up 9% and Tencent’s shares are up 6% in the last week.

But it’s not all good news out of China. Poor economic data and news that the rescue of embattled Chinese property company Evergrande seems to have stalled could have far-reaching consequences. The crisis has largely been put to the back of investors’ minds, but it could be about to return to the forefront if Evergrande fails to pay $83.5m bond interest payment on Saturday night, and therefore triggering an official default.

For now at least, the market continues to be taking a half-full view of the economic and investing backdrop, rather than a half-empty one. Next week could test investors’ resolve or prove just how resilient the market is right now.