NEW YORK (AP) – As the US economy buzzes, corporate profits flow, and stock prices peak, Wall Street investors are asking themselves a fearful question: is it going to go downhill from here?
Financial markets are always trying to fix prices now for where the economy and corporate profits are likely to be in the future. And while readings across the economy are still impressive, investors see a few areas of concern.
New variants of the coronavirus threaten to weaken economies around the world. Much of the U.S. government’s pandemic relief efforts have come to an end. Inflation is raging as the supply of goods and components lags behind increasing demand. And the beginning of the end of the Federal Reserve’s market aid is in sight.
So far, investors have largely put the nervousness aside – general metrics like the S&P 500 and the Nasdaq Composite hit record highs. In fact, major stock market averages have almost doubled since the low in March 2020.
The US is recovering from the recession so fast that many forecasters estimate the economy will expand by around 7% this year. That would be the most robust calendar year growth since 1984.
The economies outside the USA are also growing sustainably. The Chinese economy, the second largest in the world, has slowed significantly from last year, although Beijing claims it grew almost 8% from April to June. And among European countries using the euro, strong growth of almost 5% is expected in 2021.
Still, some sharp moves beneath the surface of the stock market and in other markets show a newfound hesitation and concern about the potential economic threats. For example, longer-term US Treasury bond yields have fallen, while stocks of companies most tied to the strength of the economy have plummeted.
For the time being, many voices on Wall Street see nervousness only as a tipping point: They predict that stocks and bond yields will rise over the course of the year as the economy and corporate earnings continue to grow. There are many factors behind the recent changes in the markets, particularly the sharp decline in bond yields, including some technical factors that likely made the volatility worse and could be short-lived.
However, some of these analysts also concede that the changing signals in the markets could mark a tipping point after months of gangbuster performance and frenzied optimism. The fear is not that economic growth will slow down. The fact is that any threat to the economy will weaken growth too much and too quickly, and perhaps even undo the recovery from the pandemic recession and break corporate earnings.
“We’re not seeing a standstill or a turnaround, but it’s clearly aging,” said Rich Weiss, senior vice president of American Century Investments, of the economic recovery. “We have this whole decelerating theme that ‘The Best Is Yet To Come’ is no longer the case. We have definitely reached the climax. “
When asked why investors would worry about a slowdown when growth rates seem so high that they are unsustainable, Weiss said that uncertainty can often lead investors to consider a worst-case scenario.
“The unknown is what you’re going to do,” he said. “We’ve ridden this huge reopening economy and the reflation trade. Yes, it is slowing down, but what is it slowing down on? If the labor market is still weak, are we slowing economic growth on the order of 4% to 5%, or is it slowing down to 2%? That would be a negative surprise that could stir up the bond markets and the stock markets. “
The bond market, which has a reputation for being more rational and sober than the equity market, first arose earlier this year.
The 10-year government bond yield, moving in line with expectations for economic growth and inflation, had soared above 1.75% in March after more than doubling in four months. Optimism rose that with the economy reopening and the introduction of COVID-19 vaccinations, life would return to normal. But that also fueled concerns about a sharp rise in inflation.
However, the 10-year yield fell below 1.25% last week. The month-long decline came as investors reacted more to the Fed’s insistence that high inflation appears to be temporary. The decline accelerated after some reports that showed economic growth remained strong but not quite as strong as Wall Street expected.
The stock market, which had slid to record highs, fell nearly 1% in one day last week. The decline was modest, but enough to lead some analysts to believe that stocks are finally paying attention to the bond market signal.
Instead, the S&P 500 quickly resumed records, by Monday at the latest. That’s one of the confusing things for David Joy, Ameriprise Chief Marketing Strategist.
When the bond market signals concerns about impending economic growth, it’s surprising that stocks have done so well, Joy said. The same applies to “junk” bonds, ie those issued by companies with poor credit ratings. And corporate bonds should offer more returns than government bonds than they do now.
“The bond market has often provided good early warning signals in the past,” said Joy. “I don’t know if that’s necessarily the case this time around because we don’t really know what is driving rates down.”
In addition to concerns about peak growth and virus variants, analysts point to other possible reasons for falling earnings. These include the purchase of government bonds by investors from countries where interest rates are even lower, pension funds that are switching some of their investments from stocks to bonds, and a rush of traders who are simultaneously getting out of bets on further increases in interest rates.
Although the S&P 500 is close to its all-time high, some market watchers say moves within the stock market have also shown signs of concern. In the past two months, the synchronized upward movements for many market areas have failed because of the flourishing optimism, say strategists at Deutsche Bank. While large US stocks continue to rise, smaller stocks in the Russell 2000 Index have faltered since their high in March – and the prospects for these companies are more economically tied.