20 April 2019
Traders work on the floor of the New York Stock Exchange. US stocks will remain stuck unless the Fed launches a fourth round of quantitative easing. Photo: Bloomberg
Traders work on the floor of the New York Stock Exchange. US stocks will remain stuck unless the Fed launches a fourth round of quantitative easing. Photo: Bloomberg

This is what it will take to drive a sustained US market rally

US equity markets have yet to bottom out after the Coppock Curve, a measure of trading momentum, tumbled below zero in February.

The Dow Jones Industrial Average and the S&P 500 climbed above 18,000 and 2,100 points, respectively, in late March, returning to the upper levels seen during most of 2015.

These levels compare with the peak of 18,351 and 2,134 points set in May last year.

By contrast, the Nikkei 225 and DAX indices are both more than 10 percent below their peak last year.

Technical analysis shows that when the Dow Jones and S&P 500 break previous highs, a bull market is in the offing.

However, some believe that the US market is headed for a bear cycle and any rebound will be short-lived.

It’s quite difficult to tell whether the US market is in a bear or bull cycle.

Financial asset prices have been distorted by central banks.

The US Federal Reserve and other central banks launched several rounds of monetary easing in the wake of the 2008 financial crisis which in turn impacted stock markets.

There is a close correlation between the S&P 500 index and the Fed’s balance sheet.

So every time the Fed launched quantitative easing (QE) or expanded its balance sheet, the US stock market rose.

US equities traded with huge volatility toward the end of QE.

That’s why I predicted last year that the US market might move 15 percent either way this year.

What would be the catalyst for another bull market if the Fed has yet to unveil QE4?

The US market posted a sharp rally thanks to QE, although US economic growth remained subdued.

QE underpinned the US market in two ways.

First, it pumped massive liquidity into the market, reduced borrowing costs and encouraged share buybacks, which boosted earnings per share (EPS) and share prices.

Domestic bank lending stabilized at US$1.9 trillion after QE3 ended in late 2014. That was reflected in share buybacks.

As of May 3, first-quarter share buybacks were US$91.7 billion, down nearly 40 percent or US$55.7 billion less than the previous quarter.

That is a 36 percent decline from same time last year.

The EPS pick-up of US companies and the market rally are mainly driven by share buybacks in the eight years after the start of the financial crisis.

The US market may run out of steam unless the Fed starts to pump money again.

Meanwhile, sales and profit growth of S&P 500 constituents have fallen since mid-2014 and profit margins have leveled off, even slipping in the second and third quarters last year.

In the meantime, the pre-tax profit of US companies has stayed around US$2 trillion since 2012.

The figure fell to US$1.89 trillion at the end of last year, the lowest since the third quarter of 2011.

That is an 11.5 percent tumble from the previous year, the worst since the financial crisis.

These show that earnings and other fundamentals of US companies are weakening.

The US market is under pressure because there is less cheap money to go around and the US dollar is relatively strong.

This article appeared in the Hong Kong Economic Journal on May 5.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist

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