WALL STREET HITS FRESH PEAK AS EARNINGS FEARS RECEDE / THE FINANCIAL TIMES

Wall Street hits fresh peak as earnings fears recede

Inflows into equity ETFs pick up but active fund managers miss out

Chris Flood


Sentiment towards equities received a boost from an unexpected shift in monetary policy by the Federal Reserve (Johannes Eisele/AFP)


A strong rally for the US stock market this year has propelled Wall Street to a fresh all-time high, a rebound that has surprised many investors after a savage sell-off in the closing months of 2018.

Fear of an all-out trade war between Washington and Beijing and worry over the effect of rising interest rates on US economic growth helped drag the US equity market to a 20-month low on Christmas Eve. Wall Street’s decade-long recovery following the global financial crisis appeared to have reached exhaustion.

Instead the S&P 500 has surged 24.8 per cent higher since December 24, confounding the doubters.





David Kelly, chief global strategist at JPMorgan Asset Management, says the rebound reflects growing confidence that the US economy will not sink into a recession in the near term.

“We are at a late stage in the business cycle but there is no expiration date on the recovery. The main cyclical sectors — housing, autos, capital goods and inventories — remain well behaved, which reduces the risk of a recession,” he says.

Sentiment towards equities received a boost from an unexpected shift in monetary policy in March when the Federal Reserve indicated that it would refrain from raising US interest rates for the rest of the year.

But the surprise shift in monetary policy by the Fed has also led to an inversion in the US yield curve, a historical warning sign that the economy could move into recession.

Mr Kelly is unmoved by this, describing the inverted yield curve as “a broken barometer” as a result of the reduction in US bond yields due to quantitative easing — the massive bond-buying programmes introduced by central banks in response to the financial crisis.

“It still makes sense for investors to have a modest overweight position in US equities,” he says.

Jeremy Podger, a global equity portfolio manager at Fidelity International in London, describes yield curve inversion as a “red herring”.

“The US economy still has positive momentum,” he says.




Investors also appear unperturbed by the warning from the yield curve. Inflows into US equity ETFs have picked up following the Fed’s signal on interest rates.

Matthew Bartolini, head of Americas research at State Street Global Advisors, points out that SPY, the world’s largest ETF, which tracks the S&P 500, has attracted inflows of more than $3.9bn since the start of April after registering outflows of $4.1bn over the first quarter of the year.

Traditional active fund managers have missed out. Active US equity funds had close to $28bn in outflows in the first quarter while passive US equity tracker funds gathered nearly $34bn in inflows, according to Morningstar, the data provider.

Corporate earnings will play a critical role in determining whether the stock market will make further progress or retreat.

Earnings for the S&P 500 are on track to shrink by about 3.3 per cent in the first quarter compared with the same period, a slightly better outcome than predicted by the consensus forecast among analysts.

Mr Podger says first-quarter earnings have been “encouraging”, particularly as the latest updates follow a strong showing in 2018 when generous tax cuts helped to swell corporate profits. He currently holds a modest underweight position in US equities but sees value in technology and the oil stocks where this year’s rise in oil prices has not been fully reflected in company valuations.

Morgan Stanley is more cautious. It is predicting the US will undergo an earnings recession with two consecutive quarters of negative or flat earnings growth for the first time since 2016.

“There will need to be real evidence of a turn in earnings growth for US stocks to advance much from here. The real question is what the second half of the year looks like,” says Michael Wilson, an equity strategist in New York.

The consensus forecast among Wall Street analysts is for calendar-year earnings growth for the S&P 500 to slow to 3.6 per cent this year before recovering to 11.5 per cent in 2020, according to FactSet, the data provider.

Equity valuations have also risen as a result of the stock market rally. The S&P 500 is trading on a multiple of 16.4 times 12-month forward earnings, above the long-term average of 15.3 times.

Savita Subramanian, head of US equity and quantitative strategy at Bank of America Merrill Lynch, says the S&P valuation looks “slightly stretched” based on earnings forecasts but inexpensive on cash flow measures and also relative to bonds.

BlackRock, the world’s largest asset manager, has been reminding its clients that equities historically have performed well in late-cycle periods while also cautioning against extrapolating the US stock market’s recent strong performance through to the end of 2019.

Larry Fink, the head of BlackRock, said this month that “a lot” of investors’ money remained on the sidelines.

“There’s too much global pessimism. I think you’ll see investors put money back into equities,” said Mr Fink.