Is the US market’s strong performance sustainable? | Inquirer Business
Intelligent Investing

Is the US market’s strong performance sustainable?

The US market is so far performing well in 2023, with the S&P 500 and the Nasdaq indices up by 14.8 percent and 30.8 percent, respectively, year-to-date.

This is in contrast to the poor performance of the Philippine market. During the same period, the Philippine Stock Exchange index (PSEi) was down 0.9 percent.

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However, there are many reasons why I am not convinced that the US market’s strong performance is sustainable.

One of the most important reasons is the heightened risk that their economy will enter a recession.

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There are many indicators pointing to a weak outlook. These include falling leading economic indicators, banks’ tightening credit standards and shrinking money supply.

Even the labor market, which is considered to be very strong, is showing signs of weakness. Initial jobless claims have been going up and is now at an 18-month high, while average hours worked per week is on a downtrend. Given these, it won’t be surprising to see the unemployment rate going up more significantly in the next few months.

Making matters worse is the Fed’s plan to keep interest rates elevated despite the deteriorating outlook for the economy. Although the Fed did not raise rates during its last meeting this month, chair Jerome Powell said they had no plans of cutting rates any time soon and may even resume with rate hikes later this year. High interest rates against the backdrop of slowing economic growth will make it difficult for the US to avoid a recession.

Unfortunately, the risk of a recession is also not yet priced in.

At its current level of 4,400, the S&P 500 is trading at 20.2X price-to-earnings ratio (P/E). This is above its 10-year historical average P/E of 18.9X. In past recessions, the US always traded below the said level.

And while a recession might convince the Fed to finally cut interest rates, history has shown that recession-triggered rate cuts have never resulted in higher share prices as investors focused more on the near-term outlook of corporate profits.

Lately, the bulls are pointing to artificial intelligence (AI) to justify the US market’s strong performance. After all, AI will boost productivity, addressing the problem of inflation and allowing companies to earn more profits.

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Despite only being launched in November last year, ChatGPT successfully grew its monthly active user base to 100 million by January, making it the fastest-growing consumer application in history. Meanwhile, Nvidia, which accounts for 95 percent of the graphic processing unit market for machine learning, said in May it was expecting strong revenue growth and was boosting production of AI chips to meet surging demand. This fueled a significant increase in its share price, bringing market capitalization to more than a trillion dollars. It was also the catalyst for other tech stocks’ sharp rally in recent days.

Although the outlook for AI is very positive, it’s not yet clear how big the market will turn out and which companies will succeed and become leaders.

Execution risk is very high. Because of this, I won’t be surprised if AI-related companies follow the same path as other tech stocks which rose sharply during their early days because of excitement but went down eventually as they suffered from growing pains. Only when their numbers proved that they were on the right path did the increase in their share prices become sustainable.

Because of the said factors, I remain cautious on US stocks. Although there is an opportunity for active investors to make money by trading US stocks (particularly tech stocks), I think it is important for them to stay disciplined and to strictly observe risk management strategies such as placing tight stops. Otherwise, they could suffer from huge losses if the US economy enters a recession and the market goes down. INQ

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