Wall Street returned triumphant from a long holiday weekend, pushing U.S. equities once again to new record highs on Tuesday. Yes, the Dow is starting to close in on the 21,000 level. The historic “creeper” uptrend continues as volatility disappears: It has been some 50 days since the last 1 percent intraday pullback and 90 days without closing down 1 percent.
Sell-offs suddenly seem like a relic of the past.
But the uptrend is predicated on some shaky assumptions, worrisome technical indicators and possibly misguided enthusiasm. While none of this has mattered so far, and may yet continue to be irrelevant, here are five reasons investors would do well to demonstrate some caution here amid the speculative fever burning up Wall Street.
For one, the market’s surge to new records has been remarkably narrow. That is, only a small group of stocks have been participating to the upside -- mainly in the financial and industrial sectors -- as buyers focus on shares showing upward momentum. Traditionally, this is seen as a sign of underlying fragility and limited buying power. But like many other “technical” indicators, it’s far from a hard and fast rule.
Jason Goepfert of SentimenTrader noted that the S&P 500’s march to new highs has been accompanied by fewer than 80 companies (less than 16 percent) in the index. That’s happening on a global scale as well: According to Societe Generale’s Andrew Lapthorne, out of the 1,650 stocks in the MSCI World Index, only 246 have hit new all-time highs this year.
If you had to finger a single catalyst, the uptrend of recent weeks has been powered by President Donald’s Trump’s comments that his “phenomenal” tax cut and reform plan would be released within the next few weeks. That’s boosting investors’ hopes of an economic and earnings growth tailwind, but at the consequence of a worsened short-term fiscal outlook.
Yet at the same time, investors are ignoring the specter of political turmoil as the White House has been beset by staff dissension, lingering “Russia connection” inquiries and resistance to policy changes from federal courts, state governments and even federal employees.
Moreover, Congressional Republicans seem to be following the “take it slow” approach to both tax reform and plans to “repeal and replace” Obamacare. Goldman Sachs doesn’t expect action on taxes until late this year or early 2018.
In a recent note to clients, analysts at Goldman Sachs pointed out the cognitive dissonance among investors. On one hand, they’re jazzed about the earnings kick anticipated from Mr. Trump’s yet-to-be-unveiled tax reforms. But as things stand now, sell-side analysts have cut consensus 2017 estimated S&P 500 earnings per share by 1 percent since the election.
Moreover, the “hard” economic data points have shown only a “modest” improvement, according to Goldman, and are marred by negatives such as January’s 0.3 percent decline in industrial production and the drop in new home sales.
The president’s tax reform promises may be the catalyst for the market’s run to new highs, but they’ve gotten help from investors largely ignoring a surge in reported inflation -- and thus, the rising threat of a more aggressive pace of interest rate hikes from the Federal Reserve this year.
Last week came the latest inflation news: Annual consumer prices increased by 2.5 percent in January (up from a 2.1 percent pace in December), a monthly rate not seen since 2013. A 7.8 percent jump in gasoline prices -- as last February’s energy price nadir falls further away -- was largely to blame. But price increases can be seen in other critical areas including housing costs, health care, apparel and furnishings.
Moreover, ongoing evidence of labor market tightening and an emerging shortage of skilled labor (based on National Federation of Independent Business survey data) suggests a kick of wage inflation is just around the corner. Not only will this squeeze corporate profitability but it will also add pressure on Fed policymakers to hike rates.
The Federal Reserve
And regarding the Fed, after years of hanging on every word from those policymakers, Wall Street has suddenly become tone deaf to recent hawkishness from Chair Janet Yellen and her cohorts as they admit both inflation and employment are nearing -- or are already at -- their target levels.
As a result, central bank officials are increasingly hinting that three quarter-point rate hikes are on the table for 2017. That would represent a dramatic acceleration in the tightening cycle that started in December 2015 and has, to date, only seen two quarter-point increases.
Philly Fed President Patrick Harker, a policy hawk, told reporters on Tuesday he wouldn’t take a rate hike decision off the table at the Fed’s coming March meeting. Yet according to futures market pricing, Wall Street assigns only a 22 percent chance of this happening.
So while Wall Street is betting that the good times will keep rolling, you should be aware of the forces that could make the uptrend grind to a halt, or reverse.