The market has entered an unsustainable situation. If you analyze the returns that the US stock market now offers relative to fixed income, decompensation has occurred and must be corrected one way or another: the profitable yield offered by the S&P 500 at the moment is lower than that offered by the American bond; Knowing that the stock market is an asset considered riskier than bonds, it is normal that the situation is reversed. In fact, for the last 20 years this has been the norm, until The bond, in recent months, has started to offer more profitability, reaching levels not seen since 2002.. So that this situation is corrected and the stock market can once again offer a return higher than that of the bond without suffering a crash, the S&P 500 now relies above all on two variables: Donald Trump’s tax cuts, and the promise of the development of artificial intelligence. Both elements have the potential to enhance the benefits offered by the stock market and normalize the relationship between the profitability offered by one asset and another.
Peachtree Creek Investments founder Conor Sen published his thoughts on the situation this week: “From a pure valuation perspective, bonds are currently more attractive than the stock market at levels not seen since the Great Financial Crisis. “, and adds how “to prefer the stock market to bonds before the elections, I think we must assume that 2025 and 2026 will be more inflationary, and with more growth, than were the years 2017-2018 and 2021- 2022.” At first glance, this seems to do a lot of things. “The stock market needs a lot of help from AI and tax cuts,” confirms the senator.
At present, the profitability offered by the current profits of the stock market is approximately 3.75%, according to calculations by Bloombergagainst an American bond which offers 4.3%. If an investor buys the debt security, he or she will receive that return in the form of a coupon, unless the United States defaults, which today sounds like science fiction. The premium offered by bond yields today has increased so much that it has reached levels not seen since 2002, more than two decades ago. In this context, Stock market investors need an increase in corporate profits to regain lost ground and for bond spreads to return to normal. And for this, the benefits that the development of AI and tax reductions can bring are its main assets.
It is possible for these two circumstances to occur at the same time. If Trump wins the election, bets on big tax cuts and, at the same time, imposes high tariffs on all types of imports, one of the ingredients would be on the table. The other, a big increase in productivity thanks to AI, is in the air, but has not yet materialized. And, according to this prediction, it should happen quickly enough to be able to arrive on time.
The risk, of course, is that a victory for Harris, whose platform promises a less inflationary policy than that of the former president, completely shatters these forecasts. The markets today seem to be leaning in favor of Trump in their bets, but the polls still give virtually the same chances of victory to both candidates.
One possibility raised by Jonathan Krinsky, stock analyst at BTIG, is that Wall Street is overheating and waiting for the elections to release some ballast, whoever wins. According to his predictions, the market could fall by 5% in the days following the electionsa correction that has been a long time in the making and for which the election results could be the perfect excuse. “A clear example of ‘selling information,'” he explained on CNBC.
The logic of the action/obligation relationship
A year ago, there was this convergence between the yields offered by American bonds and those offered by the country’s main stock index, the S&P 500, with its advantages. This does not bode well for stocks, as it is a circumstance that breaks market normalcy. Money always seeks the highest returns, adjusted with the lowest possible risk, and if the bond promises to return more than the stock market, many investors may decide that now is the time to move their money from variable income to fixed income, thus triggering a fall. in stock prices.
In 2024, the American stock market managed to hold on, thanks to a rebound in economic growth and its profits which supported the increases, despite the fact that, practically throughout the year, the bond offered more attractive returns. In fact, the only scenario that, just a year ago, Generali Investments analysts Michele Morganti and Vladimir Oleinikov had pointed out could save the index, occurred: an improvement in macroeconomic data that did not correspond to analysts’ consensus forecasts.
We are now back to square one and stocks need improved earnings to justify their prices and valuations, especially relative to bonds. Whether it will be a tax cut, AI development, or both is still up in the air, but the reality is that the current market situation, with these valuations between the two asset classes , doesn’t seem like it would be able to sustain itself for long.
