The market has entered an unsustainable situation. If you analyze the returns that the US stock market is now offering against fixed income, a decompensation has occurred that must be corrected one way or another: the earnings yield offered by the S&P 500 at this time is lower than that offered by the US bond; Taking into account that the stock market is an asset considered riskier than the bond, it is normal for the situation to be the opposite. In fact, for the last 20 years this has been the norm, until The bond, in recent months, has begun to offer more profitability, reaching levels not seen since 2002. For this situation to be corrected and the stock market to once again be able to give a higher return than the bond without suffering a crash, the S&P 500 is now relying, above all, on two variables: Donald Trump’s tax cuts, and the promise of the development of artificial intelligence. Both elements have the potential to improve the benefits offered by the stock market and return to normal the relationship between the profitability offered by one asset and another.
The founder of Peachtree Creek Investments, Conor Sen, published his impressions this week on this situation: “From a pure valuation point of view, bonds are currently more attractive than the stock market to levels not seen since the Great Financial Crisis”, and adds how “to prefer the stock market over bonds ahead of the elections, I think we must assume that 2025 and 2026 will be more inflationary, and with more growth, than the years 2017-2018 and 2021 were. -2022”. This, at first glance, seems like a lot to assume. “The stock market needs a lot of help from AI and tax cuts,” confirms Sen.
At this time, the profitability offered by the current profits of the stock market is around 3.75%, according to the calculations of Bloombergcompared to a US bond that offers 4.3%. If an investor buys the debt security, they will receive that return through the coupon, unless the United States defaults, something that, today, seems like science fiction. The premium offered by bond returns at this time has risen so much that it has reached levels not seen since 2002, more than two decades ago. In this context, Stock market investors need an increase in corporate profits to be able to recover lost ground and for the bond spread to return to normal. And for this, the profits that the development of AI and tax cuts can bring are its main assets.
There is a possibility that these two circumstances occur at the same time. If Trump wins the elections, bets on strong tax cuts and, at the same time, imposes strong tariffs on all types of imports, one of the ingredients would be on the table. The other, a strong boost to productivity thanks to AI, is in the air, but has not yet occurred. And, according to this prediction, it should happen quite quickly to be able to arrive on time.
The risk, of course, is that a victory for Harris, whose program promises a less inflationary policy than that of the former president, completely shatters these forecasts. The markets seem to be leaning in favor of Trump in their bets these days, but the polls still give practically the same chances of victory for both candidates.
One possibility that Jonathan Krinsky, a stock market analyst at BTIG, points to is that Wall Street is overheated and is waiting for the election to release ballast, regardless of who wins. According to his forecasts, the market could fall 5% in the days after the electionsa correction that has been brewing for a long time and for which the election results may be the perfect excuse. “A clear example of ‘selling the news,'” he explained on CNBC.
The logic of the stock/bond relationship
A year ago there was this convergence between the returns offered by the US bond and that given by the country’s main stock index, the S&P 500, with its benefits. It did not bode well for equities, since it is a circumstance that breaks the normality of the market. Money always seeks the highest returns, adjusted with the lowest possible risk, and if the bond promises to pay more than the stock market, many investors may decide that the time has come to rotate their money from variable income to fixed income, unleashing a fall in equity prices.
In 2024, the US stock market has managed to hold on, thanks to a rebound in economic growth and its profits that have sustained the increases, despite the fact that, practically throughout the year, the bond has offered more attractive returns. In fact, the only scenario that, just a year ago, Generali Investments analysts, Michele Morganti and Vladimir Oleinikov, pointed out could save the index, has occurred: an improvement in macroeconomic data that did not fit with the consensus forecasts of analysts.
Now it is back to square one, and equities need improved earnings to justify their price and valuations, especially when compared to bonds. Whether it will be a tax cut, the development of AI, or both, which is granted, is still up in the air, but the reality is that the current market situation, with these valuations between the two asset classes, does not It seems like it will be able to sustain itself for a long time.
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