Political risks are being ignored! Can the bull market in US stocks be unstoppable?

According to the Zhitong Finance and Economics APP, a long list of external factors has not been able to stop the continuous rise of US stocks so far this year, and with the arrival of the US election, political turmoil seems to be no exception.

Last week, investors' resilience was once again demonstrated. In this week, the fierce election did not prevent the S&P 500 index from reproducing the performance of 9 out of the past 11 weeks: rising, and last week, the market rose every trading day. Even markets initially hit by Biden's debate, such as US Treasury bonds, calmed significantly due to economic data supporting rate cuts.

At present, regardless of how turbulent the background is, the upward trend of risk assets continues because the market believes that the US economy is expanding enough to avoid a recession, and there are still reasons for the Fed to ease policy. Corporate credit and commodities also joined the rising trend last week.

Mark Freeman, Chief Investment Officer of Socorro Asset Management LP, said, "The Fed is still the dominant factor, and people believe that rate cuts will eventually happen." As for politics, "the question is whether there will be a major shift in fiscal policy," he said, "currently, right or wrong, people believe this will not happen."

The S&P 500 index rose nearly 2% last week, marking the largest increase since April, with data showing a contraction in the service sector and an increase in unemployment, enhancing optimism for rate cuts. Due to Biden's poor performance on June 27th triggering bets that Trump's presidency would herald looser fiscal policies, the yield on the 10-year US Treasury initially surged, but later erased this gain, as did the US dollar, which fell for the first week since May.

High Valuations

Although the continuous rise in the stock market has been welcomed by bulls, some even see the increased chances of Trump's victory as a catalyst, creating an unusual backdrop on the eve of the election. For example, compiled data shows that the current price-to-earnings ratio of the S&P 500 index is 26 times, the highest since at least any election day since 1990.

While valuation is a notoriously poor tool for judging market timing, the high valuations of the stock market, regardless of who wins the November election, may give people reason to lower their expectations for its performance.

Dan Suzuki, Deputy Chief Investment Officer of Richard Bernstein Advisors, said, "The current high valuations of US large-cap stocks suggest that their performance over the next 10 years will significantly lag behind the broader market, and because they occupy such a large share, the overall return of the US market may also be quite lackluster." However, when Biden won four years ago, the US stock market was also at a relatively high valuation, and it has been proven that this did not hinder the market from rising. Since Biden defeated Trump in November 2020, the S&P 500 index has risen by 65%.

Messages from the strategist field also indicate the difficulty of bearish views on the continuously rising US stock market. It was reported that the well-known short seller Marko Kolanovic of JP Morgan is resigning. Meanwhile, researchers at Piper Sandler stated that they will stop issuing year-end target forecasts for the S&P 500 index because excessive focus on this indicator renders their predictions meaningless.

Jeff Muhlenkamp, the head of the Muhlenkamp Fund, a hedge fund that has outperformed 97% of its peers in the past three years, said, "The stock market's performance has been quite stable this year: the seven giants have risen, while other sectors have not performed well. Considering the high valuations of leading companies, it is difficult for people to believe that this situation will continue. But so far, that's the case."

Politics has not fully impacted the market yet?

Last week, tech giants once again led the stock market, with optimism about the profit elasticity of these companies in the era of artificial intelligence. Financial stocks were seen as beneficiaries of a potential Trump victory, partly due to his deregulation agenda, but the sector's gains were only about a quarter of the NASDAQ 100 index.

Another sign that politics has not fully impacted the market is that despite Trump's increasing support for cryptocurrencies in recent months, Bitcoin still experienced a sharp decline. Traders attributed this pullback to other factors, including selling expectations triggered by the bankruptcy of the exchange Mt. Gox.

Giorgio Caputo, Senior Portfolio Manager at Gideon Strategic Partners, stated that while it is easy for people to attribute market volatility to constantly changing political trends, doing so with 4 months left until the election and with each candidate having factors that are both market-friendly and market-unfriendly in their agendas is a problematic approach. It is clear that investors are continuously getting what they want from the data: a weakening economy and gradually easing price pressures.

"This allows the Fed to step back in," Caputo said, referring to the central bank's inclination to rescue the market, "Market participants are encouraged."

Only a recession can stop the rise of US stocks?

However, some strategists hold a different view, predicting that the Fed's failure to prevent an economic recession will lead to a 32% crash in the stock market in 2025 BCA Research's Chief Global Strategist Peter Berezin stated in a recent report that an economic recession will hit the US economy later this year or early 2025, causing the S&P 500 index to fall to 3750 points. This forecast has made him the most pessimistic strategist on Wall Street.

"The commonly held belief of a soft landing is wrong. The US will fall into a recession at the end of 2024 or early 2025. Growth in other parts of the world will also sharply slow down," Berezin said.

Berezin's pessimistic outlook is partly based on the view that the Federal Reserve will be "dragging its feet" on rate cuts, and will not intentionally loosen the financial environment until the economy clearly weakens. By then, it will be too late.

Berezin emphasized that as job vacancies have significantly decreased from their peak after the pandemic, the labor market is weakening. The continued decline in resignation rates, recruitment rates, and the recent downward revisions to the employment reports for April and May also indicate a slowdown in the labor market. A rise in unemployment rates could eventually lead to consumers reducing spending to accumulate "precautionary savings," which will occur as consumers' borrowing capacity weakens due to rising delinquency rates. Ultimately, a negative feedback loop will develop in the broader economy, leading to stock market volatility.

Berezin explained, "With little accumulated savings and credit supply becoming increasingly constrained, many households will have no choice but to curb spending. Reduced spending will lead to job cuts. Rising unemployment will suppress income growth, leading to reduced spending, and further driving up unemployment rates."

Furthermore, Berezin added that perhaps most importantly, the Fed's plan to curb any economic recession through rate cuts will simply not work.

Berezin said, "It is important to recognize that what matters to the economy is not the federal funds rate itself, but the actual rates paid by households and businesses."

For example, the average mortgage rate paid by consumers is around 4%, while the current mortgage rate is around 7%. This means that even if the Fed cuts rates and mortgage rates fall, the average mortgage rate paid by consumers will continue to rise. This also applies to businesses and their loans that they hope to refinance in the coming years.

"These dynamics will trigger more defaults, causing pain to the banking system. The problems that affected regional banks last year have not disappeared," Berezin said