Why does the stock market continue to reach recording-breaking highs as we enter 2018? Our investment team weigh in on the rallying stock market and what’s contributing to the record-breaking highs. (Reading time 2:56 mins)
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Stock markets have continued to push higher in 2018, kicking off a record-breaking start to the year. The Dow Jones Industrial Average breached 25,000 points for the first time ever in one of the largest bull market runs since WWII.
Despite the news cycle continuing to spiral downward with provocations from North Korea, instability in Donald Trump’s cabinet and uncertainties around Brexit, markets have continued to steadily rise with low levels of volatility.
We explored some of the factors behind this peculiar market environment.
1. Strong corporate profitability
Corporate profits reached an all-time high in 2017, with technology companies such as Amazon, Facebook, Microsoft and Alphabet (Google) racking up another strong year of returns for investors.
Emerging technology companies – particularly those in the semiconductor space such as Micron Technology, Advanced Micro Devices and Nvidia – all rode the AI wave to double their valuations since Trump was elected in 2016.
However, revenue growth wasn’t isolated to technology as valuations in banks, healthcare and commodity-linked sectors soared in 2017.
One of the more glaring reasons for strong corporate profits is down to the U.S economy being in the midst of a slow and steady recovery from the GFC. A less obvious explanation is the fact international sales accounted for close to half of total sales in the S&P 500. This makes a global recovery all the more important, given business confidence is at a decade-high across Japan and the European Union.
As well as the U.S. markets have performed since Trump’s election, markets in Japan, Europe and emerging countries are up even more. While low interest rates from central banks around the globe hasn’t moved the needle on inflation, it has certainly raised the price of assets.
2. Business cycle unaffected by news cycle
Stock markets have experienced an unbelievably low level of volatility in a time of uncertainty, which baffles many economists.
When economists and other market participants are shocked over the resilience of the stock market during political chaos, they’re suggesting breaking stories of geopolitical uncertainty, political crises and natural disasters ought to move financial markets.
In practice, news tends to be a mixed indicator of stock market performance. While the home and front pages of U.S. news organisations were chaotic, the business cycle remained the polar opposite – positive, steady, and some even labelling it as “boring”.
Brexit’s effect on global markets was more placid than people anticipated, just as 9/11 and the Soviet Union collapse had immediate implications that were eventually overcome by the strength of the business cycle.
According to Michael Cembalest, the chairman of market and investment strategy at J.P Morgan:
“The percentage of countries in major expansion mode is about as good as it can get”.
3. No obvious signs of bubbles or imminent corrections
Inflation and unemployment are both low in the U.S. The housing market has bounced back, but new home construction is still well below the pre-GFC high.
Additionally, commercial real-estate borrowing is significantly below levels seen during the real estate bubbles of the mid-1980s/2000s. Furthermore, there’s little to indicate the U.S. Federal Reserve will panic and suddenly raise interest rates, or sell off assets in a hurried bid to combat inflation.
The outlook for the share market in 2018 continues to be favourable with strong worldwide fundamentals underpinned by synchronised global growth, positive earnings growth, tax cuts and accommodative monetary policy.
We do, however, expect stock markets to be more volatile than 2017 largely due to the upcoming U.S. midterm elections, and a new Federal Reserve chairman on the horizon.