(The opinions expressed here are those of the author, a
columnist for Reuters)
By James Saft
April 3 The Trump reflation stock market rally
has two inter-related problems: Trump and valuations.
The Trump administration’s inability to force through its
healthcare bill underlines the risks of a similar failure to
deliver tax cuts, infrastructure spending and deregulation. With
stock market valuations at historically high levels, and with
the Federal Reserve raising interest rates, this is a major
The central thesis, supposedly, behind the post-election
rally in risk assets was that Republicans, controlling the
executive and legislative branches, would force through policies
which would not only raise growth but improve the way that
growth translates into corporate bottom lines.
That may yet happen, but with the ratio of price to sales
for the S&P 500 index at an all-time high, and with the
price/earnings ratio on 10 years of earnings at a level not seen
since the dotcom bubble was bursting, there is little room for
“These all are nose-bleed levels. However, they may be
justified if Trump proceeds with deregulation and succeeds in
implementing tax cuts. His policies may or may not do much to
boost GDP growth and S&P 500 sales. Nevertheless, they could
certainly boost earnings,” market strategist Ed Yardeni of
Yardeni Research writes.
“The risk is that Trump’s victory activated a melt-up
mechanism that has nothing to do with sensible assessments of
the fundamentals or valuation.”
Certainly there has been a notable divergence between
sentiment-based economic indicators, like consumer and small
business confidence, which have surged, and those harder figures
which record actual money changing hands. The GDPNow forecast
from the Atlanta Federal Reserve sees first-quarter U.S.
economic growth of just 1.2 percent.
To be sure, sentiment can create its own reality but
analysts are revising earnings forecasts upward now at a slower
pace then they were before the election, when a corporate tax
cut and foreign cash repatriation holiday were little more than
a fond hope.
Expecting corporate America to suddenly start a virtuous
cycle of investment, employment and growth before they are
encouraged to do so by policy change is simply silly. Expecting
that policy change to happen under current management is risky.
Expecting it to work if it does happen is a speculation.
VALUATIONS AND FUTURE RETURNS
There is also the fact that a growing number of Federal
Reserve policy-makers are noting that valuations are high,
indicating that perhaps, for once, they may actually start to
figure them into their interest-rate-setting calibrations.
Boston Fed President Eric Rosengren last week said some
asset markets are “a little rich,” citing “rich asset market
prices” as a reason for the Fed to tighten more quickly. John
Williams of the San Francisco Fed also noted that the stock
market specifically “may be a little frothy.”
Williams, who like Rosengren is not a voting member of the
Fed's rate-setting Federal Open Market Committee this year, also
said the market “kind of got ahead of reality” on fiscal policy
It is possible that the market is confirmed and its rally
extended by fiscal and economic policy, but also possible that
the Fed surprises with faster tightening in part to keep markets
from extending themselves too far.
No matter how things play out, one fact remains: valuations
are at levels which in the past have delivered poor future
On some measures median valuation levels are at all-time
highs globally, and are in a zone which suggests future returns
only very marginally better than bonds.
“Higher valuations do however have a very good record of
predicting future returns,” Andrew Lapthorne, quantitative
strategist at Societe Generale in London writes.
“If you think an excess total return over bonds of less
than, say, 2.0 percent (i.e., less than the dividend) is
sufficient compensation for holding much riskier equities then
today’s valuations might be okay; if you think equities deserve
a risk premium then you have a problem.”
That is the bet stock market investors are collectively now
making, and it is hard to see it coming good without the Trump
administration bringing to reality a substantial portion of its
various promised or suggested programs. Given that the last
comprehensive U.S. tax reform was carried out by the Reagan
White House in 1986, a much different time with a much different
and more cohesive Republican Party, this is a long-shot bet.
Expect tax reform to be piecemeal and designed to deliver
easy wins like foreign cash repatriation. Much of that will find
its way back into the stock market via share buybacks.
A reflation, a pushing higher of growth and inflation back
towards 20th-century norms, is far less likely. Stock prices
should, and ultimately will, reflect this.
(Editing by James Dalgleish)