The US stock market has started the year with an erratic trajectory, continuing the trend that it experienced in the last weeks of 2024. Last year’s rally began to show symptoms of exhaustion at the end of the year, and doubts about the good performance of the S&P 500 accumulate. Wall Street is now at a key moment, in which There are some very clear signs that the American stock market is paying dearlywhich may have consequences in the medium term. In the past, the fixed income market has been a good thermometer to warn that the US stock market was overheating, and now there are indicators that warn that it is happening again. The comparison between the profitability offered by the stock market and that of the US bond is one of those signals, as is the pure valuations of the stock market compared to its history, in a context of high geopolitical and economic uncertainty.
Fixed income sales have become the great enemy of the stock market. The endurance of inflation in the United States has led investors to discount less rate cuts than expected by the Federal Reserve, and this has been transferred to the maturity yield of the country’s bond, the main risk-free asset. of international markets. Thus, the title now moves around 4.7% profitability, and at these levels the ‘T-Note’ has generated a selling reaction in the S&P 500 on several occasions in recent years.
The bonus reaches dangerous levels for the stock market
As Christian Mueller-Glissman, Goldman Sachs strategist, explains, “the correlation between the stock market and the yield of American bonds has returned to negative territory. The stock market has shown relatively high resistance in the bond sales process, and now we believe that the risk of a short-term correction is highin case there is negative news for growth,” says the strategist. This means that, the more increases in the yield of the American bond, the more the danger of a fall in the stock market index increases.
In recent years there have been several examples of the damage that a bond with yields at these levels generates in the stock market. In 2022, when the bond broke the 4% barrier for the first time in this cycle, the S&P suffered a collapse since the summer, something that was repeated in February 2023, and again, in the summer of that same year, coinciding with the highs of the US security, which reached 5% yield to maturity for a moment.
In 2024 this happened again, when the bond touched 4.5%, and now, the title is moving again at similar levels.
Debt pays more than the S&P 500 and carries less risk
The relationship between the bond and the stock market is not a coincidence, and responds to the profitability/risk logic that exists in the market. Money seeks the highest profitability, with the lowest possible risk, and now, an asset like fixed income, which is considered less risky than variable income, is offering more profitability, which can generate a rotation from the market of listed companies , towards debt securities.
The big risk now is that not only has fixed income reached the profitability offered by the stock market, but it has far surpassed it, to levels not seen since the outbreak of the crisis. dotcomthe last major stock market debacle caused by excessive overheating and too high expectations for corporate profits. Then, in 2002, it was confidence in the sector of companies most related to the rise of the Internet that ended up generating a bubble. Now expectations are placed, above all, on the development of Artificial Intelligence, an advance that promises to generate great benefits for listed firms, but which still has a lot to prove.
With the profitability of the S&P profit below that offered by the bond by almost 100 basis points (4.7% for the bond, compared to 3.76% offered by the profits of the S&P 500, according to the earnings estimates collected the consensus of Bloomberg analysts), the situation has become tense to a point not seen for 23 years, and which, then, ended badly for the stock market.
The differential with ‘junk’ bonds also sets off alarms
It is not only the sovereign bond of the United States that points to an overheating of the American stock market: in the credit market, specifically, in the so-called ‘junk’ bonds (securities without an investment grade rating by rating agencies). rating) signals are also being sent in this regard. For months now, junk bonds have offered more profitability than the stock market, despite the fact that they also entail less risk, and the differential has reached a point not seen since 2008, in the midst of the Great Financial Crisis.
Brad McMillan, chief investment officer at Commonwealth Financial Network, explains to Bloomberg how “when you look at the returns on ‘BBB’ bonds, and other types of benchmarks, there is a significant gap between them and the profit returns offered by the stock market,” indicates. “When this has occurred, it has historically preceded significant declines,” explains McMillan.
The risk of more inflation could make the situation worse
Inflation is one of the key pieces in the markets at this time, since it depends on whether central banks can continue lowering rates aggressively. The increases in bond yields are related to signs that inflation has not yet been completely tamed, and there are analysts, such as the Amundi team, who warn of the danger that the bond will continue to climb in profitability, until reaching the 5%.
Of course, today it is not the base scenario that analysts use, since only 4 of the 51 that Bloomberg collects believe that the US bond will end 2025 with a yield to maturity higher than the one it maintains at this moment.
The stock market is expensive by itself.
The debate about whether Wall Street’s valuations are now justified is extensive, and there are opinions in both directions, but the reality is that, if we look at the historical valuations that the S&P 500 has had, at this time the US index is paying very dearly, regardless of the comparison it offers with fixed income.
The PER ratio (profit multiplier) at which the index is currently trading is more than 24 times, compared to the historical average, since 1990, of 17.99 times in which the selective has moved. Thus, the index’s profit would have to increase considerably if it is to adjust to historical valuations, or the only other way to achieve this would be with a fall in the index’s price that makes the pieces fit together with the average of the past.
The political context is a challenge
The underlying geopolitical and economic situation also poses challenges for the US stock market. The war continues in the Middle East, and also in Ukraine, and there are more and more sources of political uncertainty in regions such as the European Union, where, next February, German citizens have a new appointment with the polls, and in France The Government continues to deal with a very complicated panorama on the economic and political front.
In the United Kingdom, the situation is not rosy either, and the country’s bond is picking up the slack, with increases in profitability that have led it to reach the highest levels seen since the Great Financial Crisis in 2008.
With a context like this, it cannot be ruled out that tensions may arise on some fronts, such as energy. In Europe, for example, there are already voices warning of the possibility that there could be significant increases in electricity prices this winter, due to low temperatures and an insufficient supply of gas to cover the demand that there will be. Inflationary pressure from this route has the potential to become another thorn in the side of the markets in the coming months.
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