Tom Stevenson, Investment Director at Fidelity International, comments as share prices continue to climb the wall of worry; despite no clear progress in the Gulf and with little in the way of economic and corporate data this week, investors are sticking with the positive AI narrative.
As meteorological summer arrives, the mid-year news lull has come early, with very little for investors to focus on in terms of economic data or company news. Even the big geopolitical news story in the Gulf seems to have taken a pause, with neither side showing much sign of blinking. That has left investors sticking to the prevailing positive AI narrative as the main driver of markets. And last week provided a ninth consecutive weekly rise in global stocks, the best performance since 2023 and among the longest winning streaks of the post-war era.
There may be growing talk of a valuation bubble, concerns about an oversupply of new equity as the big AI IPOs get underway and fears of persistent inflation, but the glass remains half full for investors. The rally is supported by higher earnings and rising margins – and for now that’s enough to keep the bull market on track.
Taking a step back
With little in the way of immediate distractions, it’s not a bad moment to stand back from the market and assess what’s driving the bull and what might cause it to end. First, let’s put it in context. The short-term cyclical bull market has now been running for 45 months since late 2022. That’s well in excess of the average 30-month bullish run. So, too is the 118% return since the low point.
This cyclical bull also sits within a mature secular, or long-term, bull market. There’s some dispute about when this bull really started, but a good case can be made for it beginning in March 2009, which is the obvious low point after the financial crisis. On that basis, the long-run bull has been running for 17 years, which is pushing up against the duration of the previous two big bull markets from the end of the Second World War to the late 1960s and from 1982 to the top of the dot.com bubble in 2000.
It’s interesting to look at what’s been driving shares higher. Always this is a combination of rising earnings, dividends and higher valuations. What is not always the same is the order in which these dominate. This time around, valuations took the lead initially but have more recently handed on the baton to earnings and dividends.
Looking ahead both of these continue to look like a positive driver and hopefully they will keep the bull on track even if valuations flatline or fall a bit from here. Another strong earnings season and still buoyant profit margins remain supportive. Looking at the longer run bull market, this has taken the usual path from well below the very long-term rising trend for the market to well above it. The market can stay above this trend line for a while, but the risk reward balance deteriorates the longer it stays at the top of the trend channel.
Again, it’s worth looking at what’s been driving the market higher over the past two decades. Firstly, it’s earnings and margins, which have powered ahead over that period from a low base, fuelled by technological advances in particular. Another driver of global shares has been the growth of US exceptionalism, with the US’s dominance of technology helping investors thanks to the US’s parallel dominance of stock markets.
Another factor has been so-called financial engineering. Basically, demand for shares has been high at the same time as the number of shares on offer has dwindled thanks to a combination of takeovers and share buybacks coupled with limited IPOs. The laws of supply and demand mean that a 10:1 differential has pushed the market relentlessly higher.
One concern for investors looking forward is that this imbalance looks less favourable. Growing capital investment requirements (especially in AI) mean companies are less keen to buy back their shares. At the same time, we have a few giant flotations on the horizon – SpaceX, Anthropic and OpenAI being the highest profile – threatening to swamp investors with new shares. So, the bull market has been going on for a long time. And the supply and demand fundamentals are less attractive. How much should we worry about this?
Typically, bull markets end for one of a couple of reasons. Valuations can rise to unsupportable levels, where they are not backed up by fundamentals. This was the story in 2000 – and for stock market historians, also the 1929 template. Or the bull can be knocked off track by rising inflation, higher interest rates and more competitive bond yields, forcing a downward rerating of shares. This was the 1968 narrative. The valuation headwind looks less of a worry this time around thanks to strong earnings growth. But the inflation fears are real.
The week ahead
And that brings us to one of the few significant economic data releases this week – Friday’s non-farm payrolls in America. With new Fed chair Kevin Warsh’s first meeting in charge of the US central bank coming up soon, investors will be watching this week’s job market data closely. They promise an insight into how higher oil prices are feeding into price pressures in the economy more broadly.
Recent data points to a US labour market that has been able to shrug off the war in Iran, even though a sharp rise in the oil price has created uncertainty and higher costs for both businesses and households.
The good news is expected to have persisted in May, with economists expecting another 86,000 jobs to have been added in the month, not as good as April’s 115,000 but still a strong reading in the circumstances. Unemployment is forecast to be flat at 4.3%.
At the moment, the futures markets are pricing in a 50:50 chance of a rate hike in America by the end of the year. But a stronger than expected jobs market could make it difficult for the Fed to start bringing interest rates down ahead of the mid-term elections in November.
Inflation is also on the radar in Europe this week, just ahead of the European Central Bank’s next rate decision. That is expected to deliver the first rate hike in almost three years, as inflation continues to rise further above the ECB’s 2% target. A fourth month in a row of higher inflation is expected, with 3.3% pencilled in for tomorrow’s announcement.
Europe is particularly sensitive to energy price changes, but worryingly the inflation pressures seem to be rippling out to the rest of the economy too. Core inflation, which excludes food and energy, is expected to have risen by 0.2 percentage points to 2.4%.
The ECB is almost certain to raise rates by a quarter point to 2.25% on June 11. And futures markets are pricing in a second hike before the end of the year.
