U.S. equity markets “are deeply overbought” and likely poised for a pullback, according to Russell Investments, the latest financial firm to warn about the pervasive irrational exuberance.
In its Q2 Global Markets Outlook, entitled “Fake News Rally?” Russell analysts write that the current optimism about the U.S. stock market, like the pessimism that prevailed for most of last year, is unwarranted. (The S&P 500 gained 9.5% last year; the Dow Jones industrial average 13.4%.)
“Growth has picked up, but not by enough to justify the optimism priced into the S&P 500 … U.S. equities are very expensive.”
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The report cites that the Shiller P/E ratio, which uses the 10-year average of inflation-adjusted earnings, is at its highest level “outside of 1929 and the late-1990s Internet bubble.”
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In addition, according to Russell Investments, “markets are overestimating the ability of President Trump to boost the U.S. economy and forgetting that the U.S. economy is near full capacity. This means that any Trump stimulus is likely to be offset by a more aggressive Fed to contain inflation pressures.”
The Federal Reserve will be “under pressure to continue lifting interest rates,” according to Russell, because “U.S. wages are tracking higher as the unemployment rate settles below 5%.”
The government stimulus plan has yet to be revealed, no less implemented. It’s expected to include both tax cuts and spending on infrastructure, but sentiment is growing that both will likely be less expansive than what was pledged by then candidate Trump on the campaign trail.
“President Trump has talked up federal tax cuts and infrastructure spending. However, his slim Senate majority means that stimulus is likely to be modest and delayed until 2018,” according to Russell.
In addition, Trump does not have undivided support from Republicans, as revealed by the recent failure of the Obamacare repeal and replace vote. The conservative House Freedom Caucus opposed the plan, which led Trump to lash out Thursday, suggesting that Republicans “fight” Caucus members if they don’t fall in line with his agenda.
Also, savings from the now failed health care plan were expected to make up some of the revenue lost from a tax cut plan.
Trump’s $1 trillion 10-year infrastructure plan is also expected to disappoint markets. Transportation Secretary Elaine Chao said Thursday it won’t be unveiled until later this year, and the plan is expected to focus on tax credits to private firms rather than on direct government spending, which many economists believe won’t yield the $1 trillion impact that’s been pledged nor benefit the broader economy.
Russell Investments is forecasting “mediocre” 2% U.S. GDP growth in part because fiscal stimulus “increasingly looks like a 2018 story that could ultimately prove to be watered down relative to big promises on the campaign trail.” In addition, according to Russell, is another key economic indicator: zero growth in commercial and industrial loans over the last four months, which typically happens when an economy is facing recession, though Russell doesn't expect that.
Its analysts are underweighting U.S. equities in global portfolios, selling the rally and looking to buy the next dip. Their year-end target for the S&P 500: 2,200, which is 7% below the current level.
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