Echoes of ‘Irrational Exuberance’?
After Trump’s landslide victory, the US stock markets had their best week of the year in November. The S&P 500’s November average was up 2.3 percent over October’s average. At the end of November, the index was over the 6000 mark, 5.3 percent higher than the end of October.
Although the US economy remains resilient despite the slowly cooling labor market and inflation, the current bull market appears to be focussing more on the positive aspects of Trump’s political agenda. Trump’s pledge to lower corporate taxes and increase protectionism against Chinese imports appears to favor US companies. However, the semiconductor sector and companies that rely on imported intermediate materials would pass their cost increases to consumers, putting upward pressure on consumer prices.
Without curbing government spending, cutting corporate taxes would also lead to a bigger budget deficit and higher borrowing costs. Overall, it remains to be seen if the pros of President-elect Trump’s policies outweigh the cons, to justify the current market rally.
Former Fed Chair Alain Greenspan used the term ‘Irrational Exuberance’ to describe the market sentiment before the dotcom bubble. Currently, the overvaluation of the S&P 500 index is also driven more by over-optimistic market sentiment rather than the economic fundamentals.
PMI deteriorates, consumer outlook shines
The Chicago Purchasing Managers’ Index (PMI) fell to 40.2 in November from 41.6 in October. This was below the market anticipation of 44.9. The index’s long-term average from 1967 to 2024 is 54.7. Hence the current value indicates a contraction in business activity.
The Conference Board’s consumer confidence index jumped in November to 111.7 from 109.6 in October (1985=100). The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—increased to 140.9 (1985=100) from 136.1 in October. Furthermore, the Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—increased to 92.3 (1985=100) from 91.9 last month.
A reading above 80 for the Expectations Index indicates that consumers are not concerned about a recession. For a long while the Expectation index hovered below 80. The recent improvement in consumer confidence indices reflects optimism regarding the strength of the economy.
Another 25bp rate cut before 2025
In the latest data release in October, The Federal Reserve’s preferred metric — the personal consumption expenditures price index increased to the annualized rate of 2.3 in October from 2.1 in September. This was in line with the market forecasts and investors were not fazed by the slight uptick.
The US economy continued to grow at a respectable pace in the third quarter. US GDP growth for 2024 Q3 was 2.8 percent according to the second estimate by The Bureau of Economic Analysis. This was unchanged from the first estimate. The yiel spread (the difference between the 10-year and 2-year US Treasury Bond yield) remained positive throughout November. Investors are optimistic about the state of the US economy and this optimism continues to grow after the presential election. As the unemployment rate remains stable at 4.1 percent, the latest inflation numbers are cool enough for the Fed to cut its reference rate by another 25 bp at its December meeting from 17-18 December.
S&P 500 index remains overvalued
According to Factset Insights from November 22, the forward 12-month P/E ratio for the S&P 500 is 22.0. This P/E ratio is above the 5-year average (19.6) and above the 10-year average (18.1).
We believe the S&P 500 index is approaching the bubble territory. The market rally is technical-momentum driven rather than based on strong economic fundamentals. Following Trump’s victory, the prevailing optimistic sentiment may continue also in December stretching to early 2025. The forthcoming rate cut in December would also contribute to fuelling the rally.
Our monthly S&P 500 forecast is a model-based fair-value estimate. Based on the economic fundamentals our forecasts indicate a slight drop in December. Irrational momentum-driven rallies are beyond the scope of our model.
The possible impact of geopolitical tensions is fed into the model through keyword searches (Google clicks) and the advanced retail sales index. However, these variables perform better in normal times. Our quarterly S&P 500 forecast discusses these issues in more detail.