Taking a breather, or finally running out of steam ? Where now for stocks .....?

ref :- "Bear or Bull ? Five reasons to claw or thunder " , Reuters Markets

Market commentators who are not required to make investment decisions have a much easier ride than those who actually stand or fall on their market views .... not nearly as profitable as those who get it right of course, but at crunch moments much the most comfortable place to be is sat firmly on the fence offering both sides of the argument. Last week's sell-off in share prices, including the biggest single-day drop in the S&P 500 since February, has once again prompted debate about whether we are facing one of those crunch moments. Was last week's action a major alarm bell for the longest ever bull run in US equities, or yet another minor (and possibly even healthy) pullback within the continuing charge higher ? This morning Reuters gives us five arguments for either side. Such summaries are always helpful, and the fact that they may leave investors little closer to making the "right" decisions does not diminish from their value in helping to put one's thoughts in order. Anyway .....

FOR THE BULLS :

Corporate Profits : Some things may be changing, but analysts Refinitiv are forecasting S&P 500 profits will rise 23.1% this year.

Wider Economy in Good Shape : Part of the remit of central bankers is to stop economies (and investors ?) getting carried away ..... nevertheless, last week Fed Chair Jerome Powell described the outlook for the US economy as "remarkably positive". Brad McMillan of Commonwealth Financial Network points out that in the absence of a recession, pullbacks can often be sharp in nature but seldom long-lasting.

No Problem with Higher Rates :  It was the spike in bond yields that sparked the sell-off, but higher rates need not act against stock prices so long as rate rises are gradual. Indeed, in a reflationary environment you would expect both rising equity prices and interest rates.

Market Corrections are Healthy : Disregarding any suggestions that this is an argument for those talking their own book, or seeing things through rose-coloured spectacles, there is plenty of evidence that often sharp reversals within a long bull run are a positive : they shake out the weak "longs" and correct overblown valuations.

Corporate Buybacks : Buybacks have played a big part on the way up, encouraged by an unprecedented era of cheap money. They've gone a bit quiet of late, which meant a lack of the usual support during the recent volatility. But President Trump's tax cuts are generating much higher levels of cash flow (which has to go somewhere), and Goldman Sachs expect S&P 500 buybacks to rise by 22% to $940 billion in 2019.

FOR THE BEARS :

Corporate Profits : What ? Weren't they bullish a moment ago ? Well yes ..... for this year. But  S&P 500 earnings growth is expected to fall back to 10% in 2019, and that doesn't take into account rising wage pressure and other costs (trade war related ?) that may bring the number down further. Since the bullish case is based on continuing strong earnings growth, it is vulnerable to any number of not particularly unlikely developments.

Fed Action : The "neutral" level for rates is that which neither stimulates nor dampens an economy. Where that level is exactly is a moving target, though it is climbing higher. Fed Chair Powell has said that rates will continue to move to that level (wherever it may be) and may have to go higher. If investors feel that the Fed move too far or too quickly, at the same time also tightening by reducing their balance sheet, that could threaten growth and cause volatility in equity markets.

Geo and Domestic Politics : Where to start ? We list them all regularly but in the context of this conversation the escalating trade war with China, and the resulting tariffs, is the most obvious threat to corporate America's good health. Throw in Mr Trump's propensity to pick fights with all and sundry (including his allies), and potential trouble for the Republican majorities in both Houses of Congress in November's mid-term elections and you have a cocktail designed to impact on growth and upset markets.

Bonds v Equities : There's always a contest between equities and bonds. Most typically over time, they move in opposite directions as they go in and out of favour. More recently, equities have certainly been on the up but that hasn't been shadowed by falls in bonds (and rises in yields). Returns on equities have been far outstripping those of investment grade bonds but bond yields have remained low as a variety of other factors (QE, safe-haven seeking etc) have kept US Treasuries in particular in demand. The jury must be considered still out on the future for bond yields, but many good judges see the recent break up through the May high of 3.12% for the 10yr Treasury as an end to the long downtrend in yields. If bond yields continue higher , and the "dividend premium" that shares have enjoyed over bonds is erased, the attraction of equities could take a severe beating too.

Technology Stocks : The star performers in the long bull run , leading the rest of the market higher, tech stocks have been particularly under pressure of late. Should a little stumble become something bigger (and investors begin to question some eye-watering valuations based on potential rather than current reality), will the rest of the market stumble along with them ? Is there any other other sector that could take up the slack ?

All clear then ? Yep, we thought so .....