An indomitable bull market hides its own risks


At the bedrock of the world’s financial system lies the faith and credit of the US government. The debts of the world’s most powerful country are seen as the closest thing to a risk-free asset, providing a much-needed haven for banks, asset managers and foreign governments alike. Meanwhile, the Federal Reserve, the US central bank, has become something close to the lender of last resort for the world economy — as was seen in the early stages of the coronavirus pandemic. 

Given all that, the fact that the storming of the Capitol by far-right protesters, carrying guns and homemade bombs, did nothing to interrupt the ascent of US markets is testimony to how impervious to bad news the bull market appears. Instead, markets were set on Friday to record their strongest weekly performance since positive results from the BioNTech/Pfizer vaccine in November.

Investors should nonetheless proceed with caution and question the assumptions behind this rally. The robust growth of equities is due in large part to the extraordinary monetary policies unleashed by central banks, optimism that the combinations of Covid-19 vaccines and continued stimulus will boost growth. Markets seem to have concluded the display on Capitol Hill, however disturbing, was ultimately a sideshow.

Though risks still surround the US transition of power, faith in the central bank remains strong. Many investors have concluded, after a more than decade-long bull market fuelled by cheap money, that there is little to be gained by standing in the way of the Fed. Sky-high valuations make more sense with interest rates so low and Fed officials expect these near-zero interest rates to remain until at least 2023.

There is plenty of evidence of frothiness in markets. Spacs, so-called blank cheque companies that involve their sponsors first raising money on the stock market and only then finding a private company to buy, are still booming. Bitcoin, the cryptocurrency that trades purely based on market sentiment, has rocketed to new highs. Elon Musk has become, on paper, the richest man on earth as the value of Tesla, the electric carmaker beloved of many retail investors, has shot up. Jeremy Grantham, co-founder of asset management company GMO, wrote this week that the “long, long bull market since 2009 has finally matured into a fully-fledged epic bubble”.

Others make a genuine case for optimism. Following Democratic candidates’ victories in the Georgia senate run-offs, the long-mooted “reflation trade” is back on. US Treasuries sold off following the results, with 10-year yields rising above 1 per cent for the first time since last March. Control over the presidency and both houses of Congress will allow the party to pursue a bigger fiscal stimulus. Combined with mass inoculations, this could allow a swifter economic rebound.

These assumptions, however, may prove flawed. Wednesday’s riot shows a sizeable constituency in US politics is willing to back disruption. Even political calm may not bring with it the growth investors are anticipating: new virus strains are spreading rapidly in Europe and, perhaps more worryingly for vaccine efficacy, South Africa. Vaccines may, eventually, banish coronavirus, but much economic damage could be done before then.

Even if everything works out perfectly, the combination of an end to the pandemic and further stimulus could bring higher inflation and earlier interest rate increases than expected. Investors are betting simultaneously on a “reflation trade” and on central banks keeping money cheap for longer. Sooner or later, one part of this investment case will inevitably be tested.


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