{"id":62027,"date":"2017-04-03T00:54:59","date_gmt":"2017-04-02T22:54:59","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/why-us-stock-market-pull-back-is-justified\/"},"modified":"2019-12-31T01:50:50","modified_gmt":"2019-12-31T00:50:50","slug":"why-us-stock-market-pull-back-is-justified","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/why-us-stock-market-pull-back-is-justified\/","title":{"rendered":"Why US stock market pull back is justified"},"content":{"rendered":"

Global equity markets are near all-time highs, bond markets are
\nrelatively calm, and currency volatility is reasonably low. This
\nbenign state is being fuelled, at least in part, by optimism about
\nthe US economy coupled with reduced fears of an ongoing swing
\ntowards populism in Europe.<\/p>\n

The rejection of Geert Wilders\u2019 PVV party in the Dutch election
\nhas temporarily halted the drift to the political Right we had
\nwitnessed with the UK\u2019s decision to leave the EU and the election
\nof President Donald Trump \u2013 and France\/Germany credit spreads
\ntightened in response. But we are mindful that France goes to the
\npolls in April and the electorate could yet back Marine Le Pen and
\nher anti-EU platform, although analysis indicates that she would
\nneed to secure around 10 million votes to swing a victory between
\nthe first and second round of elections. Even so, a further march
\nto populism and an eventual \u2018Frexit\u2019 would place a lot of pressure
\non risk assets, not least the European financial system and in
\nparticular the banking sector, which is lacking capital in many
\nareas.<\/p>\n

But it is the US that has been dominating our thoughts in recent
\nweeks. We had been neutral on US equities for eight months
\ngoing into the US election and the ensuing rally. Much of that rally
\nwas based on policy proposals that the market considers positive,
\nin particular President Trump\u2019s plans for corporate tax cuts.<\/quote><\/p>\n

Analysts estimate that for every 5% reduction in the corporate tax
\nrate, S&P500 earnings would rise by 4.2%. This translates to a
\n17% boost to earnings and dividends from Trump\u2019s tax plans this
\nyear (and every year thereafter). By early-March, the market was
\nalready up by 15.5%, despite none of Trump\u2019s policies coming
\nthrough \u2013 it is now more likely that any \u2018good Trump\u2019 policies will
\nbe pushed back to 2018, or may never happen at all.<\/p>\n

Re-rating has driven the lion\u2019s share of returns in recent years, and we are not confident that
\nthis can continue, particularly as the Fed \u2018removes the punchbowl\u2019 by further raising interest
\nrates. There are also risks to equity markets from tighter monetary policy and a lack of expected
\nfiscal stimulus, the combination of which would likely have negative consequences. On the
\nfiscal front, the legislative process to pass the new US administration\u2019s proposals appears to be
\nlonger than hoped, with meaningful gaps between perceptions in the House and Senate
\n(notably on Border Adjustment Tax) and reports of dissonance within \u2018Team Trump\u2019.<\/p>\n

Finally, corporate profits are likely to be eroded by higher labour bargaining power as US wages rise, while return on expenditure may also be negatively impacted depending on if and how interest rate deductibility is implemented. Moreover, the rich valuation of US stocks must be looked at in the context of meaningful returns from elsewhere, such as Europe and Japan \u2013 those other areas are competing for money.<\/p>\n

Taking all these factors into account, in early-March we decided to downgrade US equities from
\nneutral back to negative, though we remain neutral on equities overall (and currently favour
\nJapan and Asia ex-Japan).<\/quote>
\n A US equity market correction is, on balance, likely to be positively
\ncorrelated with fixed income, especially US government bonds. It is worth noting, however, that
\nwhile the Fed has brought forward the timing of its rate hikes with the recent rise, it is not
\nexpected to increase the magnitude of further rises.<\/p>\n

The market had clearly shrugged off any detrimental impacts of
\nthe President\u2019s policy proposals and we believe the S&P has run
\nahead of solid fundamentals and economic data, and as a result
\nstrength has been overstated. We also believe US equities are
\nfully valued, with the S&P priced at 22 times trailing earnings \u2013
\nthis is at the upper end of historical premia to the MSCI ACWI.<\/p>\n

Figure 1: Asset allocation grid<\/strong>
\n\"figure_1_-_asset_allocation_grid.jpg\"<\/a>