US stocks soldier on through adversity

US stocks continue to climb despite rising interest rates and squealing bond yields. The S&P 500 index has risen another 12% so far this year, with the technology-focused Nasdaq 100 up a fifth. Thank “a golden period” for company profits, says Iain Snedden of Aegon Asset Management. S&P 500 earnings rose 50% year on year in the second quarter, an “incredible number” that you usually only see during a recovery after a recession.

While mega-cap tech stocks remain in the vanguard, the boom is broad-based. Energy firms are raking in money from rising fuel prices, while banks are throwing off cash because of higher interest rates. The AI boom is also supporting strong performance at industrials, whose expertise in power management and construction is essential for the data centre build-out. Earnings growth has been so explosive that valuations have actually fallen. The S&P 500 trades on a forward price-to-earnings ratio of 19, down from 23 a year ago.

You don’t usually see valuations falling in a bull market, says Ben Carlson on his blog, A Wealth of Common Sense. Why are investors marking down companies even as they deliver superb growth? It is probably a mixture of three things.

Firstly, it prices in an assumption that the current AI splurge – and the associated profits – won’t last forever. Secondly, it reflects concerns that higher inflation may ruin the party. And thirdly, with bond yields rising, equities face stronger competition from fixed-income securities.

Donald Trump’s claim that America is the “hottest economy in the world” isn’t far wrong. The Atlanta Fed’s GDPNow tracker estimates that GDP grew at an annualised pace of 5% in the just completed third quarter. The latest PMI business survey shows activity running at the highest level in more than five years. Fuelled by “fiscal largesse”, “booming business investment” and “near-zero interest rates” after you adjust for inflation, the world’s largest economy “is building a powerful head of steam – and risks overheating”, says Mike Dolan for Reuters. That could require interest rates to climb much higher, but it is far from clear whether that would kill the bull market in US stocks.

For all the talk of government debt, households and businesses are not very leveraged, says Max Kettner in the Financial Times. Net interest payments at US companies have fallen to a “more than 20-year low”. That reduces private-sector sensitivity to interest-rate increases.

US stocks are partying like it’s 1999

There is precedent for US stocks to rally despite rising bond yields, says Sam Goldfarb in The Wall Street Journal. The 1994 yield surge, which was caused by Alan Greenspan raising rates, initially sent the S&P 500 down 8%. But it then recovered because a strong economy continued to support corporate earnings. AI-fuelled spending and hopes for a deal with Iran has many US investors feeling similarly optimistic today. That said, this could also be like 1999. Back then, rising yields initially left markets “choppy”. Shares then rallied, reaching a dotcom peak in March 2000, only to subsequently fall 49% by late 2002.

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