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Specifics don't matter any more, bulls are all in

Hussein Al Sayed is the Chief Market Strategist for the Gulf and Middle East region at FXTM, and host of the popular evening business show on CNBC Arabia, Bursat Al Alam. Prior to his current role, Hussein spent many years working in the finance sector as a dealer, trader and analyst in equities, credit and foreign exchange markets. He holds a BA degree in Banking and Finance from the Lebanese International University and is experienced in both technical and fundamental analysis.

Website: https://fxtm.co/1XgYw2A

02 March 2017

Equities analysts and strategists, including myself, have been arguing for some time that if no further details were provided on how and when the proposed U.S. tax reforms and spending plans will take place, the market rally should take a pause. However, U.S. President Donald Trump provided no new details in his speech to Congress on Tuesday, and yet, stocks surged to new highs.

The only surprise we received was Trump’s striking shift in tone which was hugely different from his inaugural address and regular messages on Twitter. But is it enough to justify this rally?

What’s even more interesting is markets now consider a tighter monetary policy a sign of confidence in economic growth and thus a reason to continue purchasing stocks, when for years post 2008 crisis it had been considered the most significant motive to dump stocks.  

The most asked question we receive on a daily basis is whether this rally still ‘has legs’? Well, fund flows suggest that investors are still willing to take the risk that will potentially lead to higher prices. Sooner or later however, investors will realise that valuations are what matter most in the longer run.

When looking at S&P 500 Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) which is currently trading at 29.5 x earnings. This takes us back to April 2002; from April to October 2002, S&P 500 dropped from a high of 1,174 to a low of 768, a total of 34.5 percent. Since then, the Shiller’s CAPE never re-visited these levels until just this week.

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Low long-term interest rates do justify to some extent higher valuations. For example, back in April 2002, U.S. 10-year treasury yields were trading above 5 percent as opposed to 2.46percent today, but as the Fed tightens more - “probably three rate hikes in 2017” - then risk-free rates will go higher and investors will require more return on their investments.

If this is the case, then expected earnings and dividends growth will be the key metrics to look for going forward. There’s no doubt that improved economic conditions, consumer confidence, and higher inflation will all lead to higher earnings growth, but what markets are currently pricing in is more than just these factors. It’s mainly about tax reforms, and assuming a reduction in the U.S. corporate tax from 35 percent to 20 percent, although difficult to calculate its impact on earnings, is expected to lift net profits from 10 percent to 15 percent, and this is what investors are betting on. 

If you still want to ride the current bullish momentum wave, pray that Trump’s tax reduction plan succeeds as soon as possible. 

Any opinions expressed here are the author’s own and should not be construed as investment advice.

Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
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