Dear America

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Dear America

With the clouds of confetti of Donald Trump supporters having just barely settled, US financial markets have surged, rapidly displacing the initial worries: the disturbing Trump candidate has morphed into a market friendly president. Since then, the Dow Jones has beaten record after record, with the other US stock exchanges following: Standard & Poor’s, Nasdaq or Russell 2000(1) which have also reached record highs. Such market synchronicity is not frequent. The last occurrence dates back to the winter of 1999 when market temperatures were considerably above seasonal averages…that was followed by a memorable thaw!

The above scenario provides cause for concern, especially since according to the Shiller P/E ratio (2) – the preferred long-term metric – the market is expensive. For the S&P, this celebrated multiple is today 27 versus a historic average of 17… A level this high has not been seen since the Internet bubble (though reaching a peak as high as 44!).

Is the situation different this time? Just raising this question is to open oneself up to mockery so much that this affirmation –”this time is different” – has often been a harbinger to a stock market disaster. In this case, certain measures announced by Donald Trump could give credence to this affirmation, at least in the short term. The massive tax cuts in favour of US companies which could boost their earnings by more than 10% is the most emblematic of these measures.

However, the high prices of the market also reflect more structural differences such as the increased longevity of holders of stocks or the “consumption” of US stocks by an increasingly larger number of investors (with these stocks accounting for 55% of the MSCI World index). More simply, it may also result from the scarcity of supply: the number of listed companies in the United States has been declining since 1996 – from 7,500 at the end of the 1990s to 3,700 today. The name of the largest US index, the Wilshire 5000, thus no longer fits: today it counts only… 3,515 stocks.

The first cause of this attrition: more and more large-size companies are obtaining financing and shareholders without having recourse to organised markets. UBER with its probable market capitalisation of €30 billion is a striking example. The second reason, purely mathematical: the number of the pieces of the pie has decreased. Accordingly, the balance of new companies listed minus companies acquired through takeovers as well as the number of shares repurchased by their parent company is now negative, and has been so since 2010: US stocks are thus increasingly expensive because they have decreased in number.

In consequence, as we enter a phase of market forecasting, the question of the possible overvaluation of the US stock market is raised. Expensive in relation to historic references though sustained in the short-term by strong political measures and benefiting from a general context of scarcity, it is still rising, though slowly: it took the S&P nearly 643 days to register its last 100 point increase. This no doubt means it is this pace which must be watched. The end of market trends is often announced by sudden accelerations and herd behaviour. We are not yet there though 2017 could be another year of excessive confidence.

 

(1)  The small-cap stock market index covering the bottom 2,000 stocks in terms of market capitalisation.
(2) Shiller price-earnings ratio: calculated as price divided by the average of ten years of earnings (moving average), adjusted for inflation to provide a long-term perspective.