Nothing appears to stop the bullish run in equity markets that took the major US indices to new record highs last week. The S&P 500 added 2%, bringing its year-to-date gains to 25.1%. The robust performance came despite the Federal Reserve’s announcement that it will begin normalising policy by winding down its asset purchases by $15 billion a month. The Nasdaq Composite is catching up with the S&P 500 gains and ended last week at a new record at 15,971.
The hefty year-to-date gains may worry some investors, especially in stocks and sectors where valuations look overstretched. Still, with the volatility index trading near 2021 lows, there doesn’t seem to be much concern. Unless there is an unpredictable shock, I continue to see further potential for new record highs in the remainder of the year. Here’s five reasons for the bull market to remain intact:
1. The Fed passed the test of tapering without upsetting markets. While inflation is at decade highs, officials continue to believe it’s transitory and there is no reason to tighten conditions prematurely. The labour market needs to heal and we’re not at full employment yet, hence another reason for rates to remain low through 2022. Overall monetary conditions will remain loose even as the Fed begins to scale back purchases of assets.
2. The US House of Representatives approved President Biden’s $1.2 trillion bipartisan infrastructure bill late last week, with $550 billion to be spent on roads, bridges, and other projects. This bill should continue supporting economic growth and increase demand for basic materials.
3. The latest earnings season showed that profits and revenues were still robust despite the economy slowing down in the third quarter. More than 80% of S&P companies reported a positive EPS surprise and 75% surprised on the revenue side. In addition, profit margins stood near record highs in another sign that most corporates could pass higher costs on to consumers.
4. Economic data is finally showing signs of improvement after stalling over the last few months. Unemployment dipped to 4.6% after job creation roared back in October, with non-farm payrolls rising by 531,000, which beat estimates of 450,000. More interestingly, the Supply Management Service index advanced to an all-time high reading of 66.7 from 61.9 in September. This indicates that consumers are highly active and will continue to be the key driver in the final three months of the year.
5. US Treasury yields have tumbled despite robust economic data. The benchmark US Treasury 10-year yield fell to its lowest levels since September below 1.45%. This has taken real yields below -1% and should discourage investors from rotating from stocks to bonds. As long as yields remain depressed, high equity valuations remain justified.