The S&P 500 index, which takes into account the capitalization of hundreds of the largest American companies, is at an all-time high. Enterprises posted profits, inspiring optimism to investors. This is expla-ined by the recovery of t-he world economy. But t-here are also serious concerns: a bubble has form-ed in the US stock market that can collapse everything.
At the highs
On October 21st, the S&P 500 broke its all-time high, closing at 4549.79 points at the end of the day. The index went up sharply after the congressional decision on the government debt ceiling, which put an end to the confrontation, which threatened to default.
Now quotes are accelerating on expectations of success in negotiations on a massive $ 3.5 trillion government spending package. This is speculated to support economic growth, but with less corporate tax increases than President Joe Biden’s plan envisioned.
It also helped that Everg-rande, a troubled Chinese r-eal estate developer, avoided default by paying out $ 83.5 million to bondholders. However, the main pleasant surprise came from the reporting season. Financial results of 87% of companies from the S&P 500 exceeded analysts’ forecasts. Almost all sectors reported profit growth.
Nevertheless, the most interesting is yet to come. At the end of September, the head of the Fed, Jerome Powell, announced that by the middle of next year, the quantitative easing (QE) program would be phased out completely. As part of this policy, the American regulator sent $ 120 billion of liquidity to the markets every month.
Now they will cut by 15 billion dollars a month: ten in government bonds and five in mortgage bonds.
That is, the stock market will lose some of its liquidity. It was the same after the global financial crisis of the last decade. After overcoming the effects of the recession, the Fed stopped buying assets from the market, which led to a sharp correction.
As noted by Sergei Vakhrameev, head of the analysis of shares of foreign issuers at Sinara investment bank, due to high inflation (the consumer price index in the US has been increasing for several months at a rate of more than five percent year on year), the Fed may tighten monetary policy, raise rates, which will reduce the capitalization of companies and the market as a whole – by ten to fifteen percent.
And according to financial analyst, trader Artyom Zvezdin, interest in the US stock market may weaken due to problems in the economy. These are, in particular, the endlessly growing real estate prices and the volume of mortgage loans. Then the correction can be more significant – 25-30 percent.
At whose expense the banquet
Since the start of the pandemic, Wall Street has been bathed in liquidity. The Fed’s super-soft monetary policy pushed rates to a minimum and brought more than $ 4 trillion into the financial system – they were just printed. And this is comparable to the GDP of Germany.
“All this had to be inve-sted somewhere, so the sh-ares went up. The market h-ad a bubble. The current q-uotes of many companies a-re based only on the expectation of good results in the future,” says Evgeny Shat-ov, partner at Capital Lab.
This was discussed back in the first wave of the pandemic – in the spring of 2020, when the Fed was buying up assets in virtually unlimited quantities. As soon as this “pumping” stops, the bubble can burst.
According to billionaire investor Jeremy Grantham, the current situation is even more dangerous than the one that prevailed before the Great Depression. In 1929, the market was on the rise and, despite all the optimistic forecasts, collapsed. So today, negative signals are simply not noticed. “The market shrugs off both the news about the upcoming rise in interest rates, and the information about the refusal of the Fed to buy bonds,” – explained Grantham.
Vincent DeLuard, strategist at brokerage StoneX, points out that “trillions of dollars poured into index, exchange-traded and other passively managed funds.” This resulted in “a structurally higher share price, not related to fundamentals.”
As of the end of July, $ 7.3 trillion was held in passive public and exchange-traded funds, which invest primarily in US stocks, according to Morningstar. There were 6.6 trillion in comparable actively managed funds.
According to Rob Arno-tt, founder of Research Affiliates, which oversees $ 171 billion in mutual funds and ETFs, today’s quotes are justified, provided that “corporate profits continue to rise from the current colossal, unseen heights.” Given the uncertainty in the global economy and the COVID-19 situation, this scenario is unrealistic.
In the event of a sharp correction in the American stock market, the world stock exchanges will be in trouble – there will be a do-mino effect. The FRS will announce the beginning of the QE rollback at the next meeting on November 3.