US equities continue higher as interest rates rise and bond yields spike. What is driving the rally?
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US stocks keep climbing even as interest rates rise and bond yields squeal. So far this year, the S&P 500 is up another 12%, while the technology-heavy Nasdaq 100 has gained a fifth. Iain Snedden of Aegon Asset Management attributes the rise to "a golden period" for company profits. S&P 500 earnings jumped 50% year on year in the second quarter - an "incredible number" usually seen only during a recovery from recession.
Mega-cap tech stocks still lead the pack, but the gains extend well beyond them. Energy companies are collecting larger profits as fuel prices rise, and banks are generating more cash from higher interest rates. Industrial firms have benefited from the AI boom as well: their work in power management and construction is needed to build out data centres. Profits have grown so quickly that valuations have fallen despite the rally. The S&P 500 now trades at a forward price-to-earnings ratio of 19, compared with 23 a year ago.
"You don't usually see valuations fall during a bull market," Ben Carlson writes on his blog, A Wealth of Common Sense. So why are investors cutting the value they place on companies that continue to deliver superb growth? He suggests that three factors are probably at work.
Donald Trump's claim that America has "the hottest economy in the world" is not far off. The Atlanta Fed's GDPNow tracker puts growth at an annualised 5% for the third quarter, which has just ended. A recent PMI survey also found business activity at its strongest level in more than five years. "Fiscal largesse," "booming business investment" and near-zero interest rates after inflation have all helped drive the expansion. The world's largest economy "is building a powerful head of steam and risks overheating," Mike Dolan writes for Reuters. Rates might therefore have to rise much further, though it remains unclear whether that would end the bull market in US stocks.
Despite the concern over public debt, American households and companies carry relatively little debt, according to Max Kettner in the Financial Times. US businesses' net interest payments have dropped to their lowest level in more than 20 years, leaving the private sector less exposed to higher interest rates.
US stocks are partying like it's 1999
Rising bond yields do not always stop US stocks from climbing, Sam Goldfarb writes in The Wall Street Journal. In 1994, Alan Greenspan's rate increases drove yields higher and pushed the S&P 500 down 8% at first. The index recovered as a strong economy kept corporate earnings growing. AI-related spending, along with hopes for a deal with Iran, has left many US investors just as upbeat now. But there is another comparison to consider: 1999. Yields rose then, markets turned "choppy," and shares eventually surged to a dotcom peak in March 2000. By late 2002, they had fallen 49%.
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