When the Nasdaq Composite index first spent two days above the 5,000 mark, it signalled the last gasp of a spectacular bull market. Confidence in internet companies’ power to change the world and mint fortunes was about to collapse.
Seventeen years later the market has hit a milestone of 6,000, part of a run of record highs for global equity markets. While stocks have again been rising for several years in a row, and the latest surge was propelled by gains for the biggest technology companies, the environment is very different.
Politics has enthused investors, who have ploughed more than $195bn into funds that buy stocks across the world since the US election in November. Donald Trump’s surprise win, and hopes Republican party control of government will produce pro-business policies, jolted markets higher in a run that has since spread beyond US shores.
This week European stock funds reported their largest inflows since late 2015, buoyed by investor expectations that the first round of French elections have sealed the presidency for independent centrist Emmanuel Macron, and so eliminated a key risk to the euro project from a hardline Eurosceptic.
At the same time investors have started to make transatlantic comparisons. European companies are cheaper than those in the US, its rebound less old. Even if American stocks are not primed for upset, the argument goes, Europe offers greater upside.
Peter Oppenheimer, strategist for Goldman Sachs, says since the financial crisis the US has been the default destination for global investors, because it offered low risks and growth when there was very little available worldwide, until now. “For the first time in six years, global growth and profit expectations have been revised upwards. Earnings revisions have been stronger outside of the US,” he says.
In Europe, for instance, the consensus of investment bank analysts is for corporate earnings this year to be 18 per cent ahead of what was reported in 2016, thanks in large part to dramatic rebounds in the profits of mining groups and banks.
The share of capital allocated to continental equities is at a 15-month high, according to a Bank of America fund manager survey. “People are increasingly interested in Europe as an investment,” says David Kelly, chief global strategist for JPMorgan Funds. “People had been overly optimistic of US politics on policy and equity returns, and too pessimistic about European elections.”
Judged in dollar terms, thanks to a weakening of the US currency this year, several European indices are ahead of the S&P 500, and the Euro Stoxx 50 index has kept pace with the more than 12 per cent gain for the Nasdaq Composite.
Europe tends to be favoured as a “least worst” option, rather than for outstanding cheapness, however.
“A lot of the attractiveness for Europe is the valuation of the US looks pretty punchy,” says Andrew Lapthorne, a quantitative strategist for Société Générale.
He attributes the difference in corporate profitability on each side of the Atlantic to two factors: use of debt and the banks. Side by side, European businesses and their US counterparts tend to have similar profit margins and generate similar earnings relative to their assets.
US companies’ greater borrowing has benefited shareholders, at the potential cost of fragility should the economy turn, while Europe’s banks are mired in problems.
“Near zero interest rates coupled with depressed nominal economic growth leave banks in an awkward position. They need higher rates to generate better margins but at the same time require low rates to avoid killing off any nascent recovery,” says Mr Lapthorne.
Yves Bonzon, chief investment officer for Julius Baer, is also less sanguine about the outlook. The Swiss investor sees in pro-Europe and pro-establishment Mr Macron support for a flawed status quo, and argues the European Central Bank should remove negative policy rates to support the banks while it has the chance.
“Not normalising interest rates this week after the French election was a missed opportunity,” he says.
Indeed, nagging doubts about the ability of a handful of powerful central bankers to manage a recovery are not hard to find. Bond investors also talk about avoiding, or actively betting against the value of Italian sovereign debt given the size of its debt pile, the largest in the eurozone, a stalled reform agenda and widespread support for Eurosceptic parties.
Some ebullience drained from US markets after Trump administration officials sketched the outlines of a tax plan on Wednesday. Many investors questioned the feasibility of big cuts to headline corporate tax rates against the opposition of legislators who are against deficit spending.
The US economy remains central to world growth, and some argue that bond markets are flashing a warning sign over the stamina of the so-called reflation trade. Fears for substantially higher benchmark Treasury yields, as the Federal Reserve pushes up interest rates, have faded in recent months even as stock markets have set records. Market measures of inflation expectations slipped from near three-year highs.
“It wouldn’t surprise us to see some correction given the valuations and highs we’re hitting,” says Scott Mather, Pimco’s chief investment officer of core strategies.
“The real-time growth indicators — the hard indicators — [are] still indicating we’re still in a low 2 per cent growth trajectory. It’s not 3 per cent and it’s not far from last year,” he says.
Mr Oppenheimer points to two risks from the bond market.
One is a destabilising move upwards in interest rates, producing widespread bond market volatility and denting the prospects for companies carrying large amounts of debt.
The other risk would be if it signals stronger worldwide economic growth since the middle of last year has crested, undermining the assumptions that have underpinned rising markets. “The world over it’s a profit recovery story,” he says. “We can’t buy anything because it’s cheap.”