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Stock markets undergo ‘risk reset’ as indices notch new records

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Growing optimism about the world economy and improved corporate earnings is driving stock markets to record highs, prompting analysts to forecast further gains in what some describe as a “risk reset”.

Wall Street’s S&P 500, the tech-dominated Nasdaq Composite, Japan’s Nikkei 225, Germany’s Dax and France’s Cac 40, among other indices, have all hit their highest-ever levels in recent weeks, amid hopes that central banks have succeeded in taming inflation without triggering a downturn.

Goldman Sachs and UBS have upgraded their year-end forecasts for the S&P 500 this year, and this month Bank of America raised its year-end prediction to 5,400 — about 5 per cent above the index’s current levels.

“It’s like a reset of the risk cycle,” said Evan Brown, a portfolio manager and head of multi-asset strategy at UBS Asset Management. “Everyone’s been anticipating a recession for a long time and it hasn’t materialised.” He described the growing enthusiasm for stocks as a release of pent-up risk appetite.

While equities markets rallied in December on the back of hopes that the US Federal Reserve would cut interest rates as many as six times this year, the rally has continued even though investors have scaled back their expectations to only three or four cuts.

Since a painful 10 per cent correction between July and October, the S&P 500 has risen more than 25 per cent. Wall Street’s benchmark index was up 0.8 per cent on Tuesday, having fallen slightly over the previous two sessions. It has gained in 16 of the past 19 weeks. The Stoxx Europe 600 index rose 1 per cent.

Tuesday’s equity market gains came in spite of data showing US consumer price inflation was modestly above expectations last month. February’s rate of 3.2 per cent — economists’ had forecast a reading of 3.1 per cent — led to a sell-off in US government debt and a small reduction in bets on a June interest rate cut.

Analysts say a critical consideration for equity investors is the growing hope, bolstered by historically low unemployment rates and resilient economic growth, that the US and other economies will be able to effect a soft landing this year.

“If you’re pricing out rate cuts because everyone is getting more optimistic about the economy as opposed to worrying about inflation, that’s a pretty good mix,” Brown said.

Corporate earnings have also bolstered the rally, with artificial intelligence chipmaker Nvidia up nearly 80 per cent this year after reporting bumper profits.

Companies on the S&P 500 collectively beat earnings per share expectations by 7 per cent during the fourth-quarter earnings season, according to JPMorgan figures, with sectors such as consumer stocks and communication services confounding expectations that higher borrowing costs would hit profits.

Late last year, “every equity strategist on the planet was saying there would be an earnings correction at some point in 2024”, said Manish Kabra, head of US equity strategy at Société Générale. “Now we’re forecasting 40 per cent earnings growth for the Nasdaq 100 for the first half of the year and strong profits in Europe, too.”

Morgan Stanley’s team last week predicted that pan-European indices “could keep rising like it’s 1995”, which would represent a gain of about 12 per cent from current levels.

Many analysts maintain that the current AI-inspired rally is far better founded than the tech bubble of the 1990s, which led to a crash in 2000.

Line chart of S&P 500 12 forward P/E ratio (Bloomberg estimate) showing US valuations are high but far from dotcom bubble levels

Back then, “profits for many companies were pipe dreams, not reality”, said Liz Ann Sonders, chief investment strategist at Charles Schwab.

“You’re not getting the broad overvaluation of companies that don’t make money the way you did in the tech bubble,” said Que Nguyen, Research Affiliates’ chief investment officer for equities. “Yes, Nvidia is valued at about 70 times earnings. But they actually have earnings.”

However, in a sign of potential froth, the prices of bitcoin, a magnet for speculators, and gold have hit new records this past week.

“It’s been more euphoria around themes rather than the broader market,” said Savita Subramanian, head of BofA’s US equity strategy, of the stock market mood.

Other analysts have warned that stock valuations are relatively high despite the strength of earnings. JPMorgan warned this week of “early signs of exhaustion in the rally”, with a “better-than-goldilocks outcome” becoming the market consensus.

Ian Harnett, co-founder of Absolute Strategy Research, said the rally felt less as if “there’s a lot of fundamental investing” and more that “the professional investors that we work with have shortened their time horizon”.

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