Recently, the US presidential elections ended, dissipating the uncertainty weighing on the equity markets. A few weeks before the end of the year, the main stock indices have accumulated more than acceptable revaluations: the S&P 500 index and the EuroStoxx 50 index have experienced revaluations of 24% and 7% respectively. We will then review the situation and outlook for the economy and stock markets. To do this, as on other occasions, we will focus on the United States due to its importance.
From an economic point of view, our most likely scenario remains that of soft landing: Inflation is easing (see graph) without harming growth and unemployment continues to grow. Until the situation changes, the Federal Reserve (Fed) has the option to continue lowering interest rates, and stocks and fixed income tend to do well in this environment.
Regarding the markets, we identify several dynamics that predict the continuation of the positive trend in stocks, at least until the end of the year. First of all, the general trend in the stock market is bullish. It is true that this year, the increase was strongly concentrated in the most capitalized companies, which are also those which weigh the most in the indices. However, we observe that more and more companies are improving little by little.
Second, the better performance of cyclical sectors (financial, industrial, technological and consumer discretionary) against defensive sectors (basic consumption, health, electricity and real estate), a sign that investors continue to have confidence in economic expansion. Within cyclical sectors, the particularly positive performance of the financial sector stands out, suggesting that an imminent deterioration of the economy is not expected.
Third, credit conditions remain favorable, favoring business financing at competitive rates. The credit spreads that companies pay to issue debt continue to narrow, hitting their lowest level in several months. This situation facilitates the expansion of the company, which can translate into a positive impact on its financial results and stock prices. If the economic outlook changes, credit deterioration could be expected, which is not currently observed.
Fourth, investor sentiment reflects a high level of optimism, but without reaching euphoria or extreme overweighting of stocks. Therefore, this factor still does not constitute an obstacle to the continued rise of the stock markets.
Fifth, we find ourselves in a historically favorable seasonal period for the stock market, a trend that tends to extend into the start of the new year, which reinforces the expectation that higher levels could be reached in the stock market .
Despite these positive factors, We find two factors that could slow the rise of stock markets. On the one hand, the stock market valuation remains high, both in absolute and relative terms.
In absolute terms, the S&P 500 index trades at 20 times expected earnings for the next 12 months, above its historical average of 15 times.
In relative terms, and given the current level of interest rates, equities have lost their attractiveness compared to fixed income securities. For example, the ten-year US government bond offers a nominal yield of 4.45%, and the TIP (government inflation-linked bond) offers a real return of 2% over the same duration.
In conclusion, taking into account the factors explained above and in the absence of significant changes in the economy and/or the markets, it is likely that the good tone of the stock market will continue until the end of the year, which will allow us, now, to continue investing in variable income.
