US stock market gropes new highs; does it still have growth fuel?

U.S. stock market indexes are hovering near new all-time highs, and according to some Wall Street strategists, there are strong indications that prices will continue to rise, even if the geopolitical climate is tense and valuations are high.

Last week, the Dow Jones Industrial Average hit a new high of 42,352 points, while the S&P 500 was slightly below last month's record high of 5,762 points after the US jobs report allayed fears of a slowing economy. The United States added 254,000 nonfarm payroll jobs in September, well above economists' estimates of 150,000, while the unemployment rate fell to 4.1 percent from 4.2 percent in August, according to the US Department of Labor.

Sonu Varghese, strategist at the Carson Group, says the labor market report, along with the continued moderation in inflation, is evidence of rising productivity. "This should keep the Federal Reserve on the path to cutting interest rates - an additional benefit for the economy and markets," Varghese said, as quoted by Business Insider.

The Nasdaq Composite, which includes knowledge-intensive companies whose performance is more sensitive to economic dynamics and interest rates, has also rallied over the past two months, but is below the all-time high reached in July this year.

• Ned Davis Research: "Absent a policy error by the Fed, a hard landing in the economy or an external shock, the most likely scenario is a continuation of the market's rise"

The current bull market, which is already two years old, can last at least another twelve months as long as three elements continue to support prices, according to a report by strategists Ned Davis Research published last week in Business Insider.

According to the research firm's team, from 1949 to the present, there have been thirteen bull markets that have lasted at least two years, and each time stocks continued to rise in the third year, except when the economy went into recession or a Black Swan event occurred, such as the sovereign debt crisis in Europe or the United States' credit rating downgrade in 2011.

In one case, the bull market ended after the Fed reversed the interest rate cut decision, which spooked investors.

"Bull markets don't die of old age," strategists wrote in the report, quoted by Business Insider. "In our view, the table shows that, absent a policy error by the Fed, a hard landing in the economy or an external shock, the most likely scenario is a continuation of the bull market."

• "We remain bullish on US equities, both in absolute terms and relative to bonds and cash," says strategist Ned Davis

Among all bull markets lasting at least three years since 1949, the median stock gain in the third year was 13.1%. The current market began in October 2022, and since then the S&P 500 has risen by about 60%, an evolution that was largely based on three catalysts, according to Ned Davis.

The first is disinflation, meaning the tempering of inflation that has "defined" the current "bull" market, according to the research firm's strategists, who pointed out that prices are moving slightly closer to the Fed's long-term inflation target of 2%.

The second factor is related to avoiding recession in the United States, according to the Ned Davis team, which argues that the economy needs a soft landing for the stock market to continue to perform. In the opinion of the strategists, the risks of recession seem "low in the short term", given that the GDP remained at a robust level of 3% in the last quarter.

The third element is related to corporate earnings growth which needs to be solid for markets to continue their upward trend. For the third quarter, S&P 500 issuers' earnings growth was estimated at about 4.6%, according to FactSet. If expectations come true, it will be the fifth consecutive quarter of growth, according to the analyst firm.

According to strategists, as long as these positive factors remain in play, the market can continue to rise. "We remain bullish on US equities, both in absolute terms and relative to bonds and cash," the Ned Davis team wrote, according to Business Insider.

• Profits of companies in the S&P 500 will increase by 4.7% in the third quarter, according to UBS estimates

The third-quarter financial reporting season kicks off this week, a key test of the strength of the U.S. equity market's uptrend, as companies need to show healthy profit growth and good prospects for next year to prop up valuations which have risen in recent months, according to Reuters.

The S&P 500 currently trades at a multiple of 21.5 times trailing-twelve-month earnings estimates, near a three-year high and well above its long-term average of 15.7, according to LSEG Datastream . "One of the few arguments the bulls can make to justify these high multiples is that corporate earnings growth will continue even at these high levels," said Sameer Samana, senior strategist at Wells. Fargo Investment Institute, quoted by Reuters. "Since prices have increased, it is probably necessary that the increase in profits be well above the estimated levels".

UBS strategists expect profits of companies in the S&P 500 to increase by 4.7% on an annual basis in the third quarter. But if the historical rate of positive earnings surprises is taken into account, the likely increase is 8.5%, writes Reuters. "Such increases in profitability may be needed to fuel further increases in the stock.

Since 2010, the total return of the S&P 500 has closely tracked the growth of companies' profits and dividends," says Jack Ablin, chief investment officer at Cresset Capital. But since the start of 2023, the index has pulled ahead, now sitting 18% above levels estimated based on current earnings and dividends, according to the strategist, who said: "Certainly the market is anticipating fairly solid earnings and growth in dividends".

• Mona Mahajan: "We believe that the fundamentals of the bull market expansion remain intact"

Mona Mahajan, investment strategist at Edward Jones Investments, says there are several reasons for concern for equity investors, including escalating tensions in the Middle East and the US presidential election.

Last week, Iran launched a missile attack on Israel, whose military is now preparing a "serious and significant" response, according to the Times of Israel.

"In our opinion, the risk of a major escalation in the Middle East remains, for the time being, a tail risk event (n.r. for which the probability of occurrence is low, but greater than three standard deviations from the mean, according to a normal distribution). From a market perspective, such an escalation may trigger a sense of caution and lower oil and energy supply, along with higher prices. However, given that the US and other economies have been able to increase oil and energy production in recent years, particularly in the post-pandemic era, some of the risk of supply disruptions has been mitigated," wrote Mona Mahajan , in his latest weekly analysis.

With the US presidential election less than a month away, the strategist pointed out that historically market volatility has tended to rise in the weeks leading up to the election.

Stock markets typically experience a pullback before an election given the uncertainty and, in some cases, anxiety about the possible outcomes. However, in the coming weeks, the stock market tends to recover regardless of which party is in the White House, perhaps as certain uncertainties dissipate and investors can once again focus on opportunities," wrote Mona Mahajan.

According to the most recent YouGov poll for The Economist between September 29 and October 1, Democrat Kamala Harris leads Republican Donald Trump with 48 percent of voting intentions to 45 percent, but the three-point difference also corresponds to the margin of error of the survey, according to News.ro.

According to the Edward Jones Investments team, after the market's strong growth in the first three quarters of the year and given the uncertainty on the political scene in the United States and the general geopolitical climate, it is possible that in the coming weeks stocks will experience some volatility.

However, strategists would use market pullbacks as opportunities to diversify, rebalance and add quality investments at better prices.

"We believe the fundamentals of the bull market expansion remain intact: The Fed is on track to cut interest rates, inflation continues to moderate gradually, and the US economy appears poised for a "soft landing" (no recession). In addition, corporate profits are on track for double-digit growth this year and possibly next year (according to Bloomberg). We believe both equity and bond markets remain robust against this backdrop, especially as they overcome near-term uncertainties," wrote strategist Edward Jones Investments.