If ever markets defied explanation, it is now. For the past 100 days, the world’s attention has turned to the presidency of Donald Trump. As events in Washington have generated such excitement and controversy, the tendency is to look to the president when searching for an explanation for a hectic few months on global markets.
But the market narrative does not fit the political narrative. In the past week, US markets have passed two landmarks that seem incompatible with the political drama. First, the Nasdaq Composite index reached 6,000. This was an event many seasoned investors assumed they would not live to see. The tech-heavy Nasdaq peaked at 5,000 in early 2000, during the dotcom bubble. Historical precedents suggested that after such speculative excesses it can take more than a quarter-century to recover.
Tech stocks have not only recovered, but are leading the market. All the Fang stocks — Facebook, Amazon, Netflix and Google — hit new records this week. Add Apple and Microsoft, and just six tech companies account for 29 per cent of the rise in the S&P 500 since Mr Trump was inaugurated.
If this sounds like 1990s-style “irrational exuberance”, it should do. A Yale University survey found that a majority of investors believe simultaneously that the market is too expensive and that stocks will rise further. The psychology of “too expensive, but can sell to a greater fool before the crash” is a hallmark of dangerous speculative excess.
And yet. Excitement about Mr Trump, which drove a huge “Trump trade” in the first weeks after the election, has dissipated. The companies that pay the highest tax rates, and thus stand to gain the most from tax cuts, have lagged behind companies with low tax rates. Once the first attempt at healthcare reform collapsed, investors largely gave up on imminent tax reform. This week’s underwhelming launch of the policy did not change their mind. There may be some hysteria in the markets, but it is not hysteria about Mr Trump.
This brings us to the week’s other landmark. On Thursday, the Vix index — Wall Street’s “fear gauge” of how much investors pay to hedge against future volatility — dropped to its lowest level in three years. Apart from one day in 2014, the Vix is at its lowest since the financial crisis a decade ago — quite something when potential nuclear confrontations are in the headlines.
Friends and foes alike can agree that it is not Mr Trump’s style to calm things down. While raising opportunities, his actions of the past 100 days should also raise perceived risk, and volatility. What is going on?
The best explanation is that despite our tendency to attribute everything to Mr Trump, market behaviour is not his responsibility. US markets have climbed steadily since 2009. Nobody would attribute this primarily to former president Barack Obama. The prime drivers have been central banks who bought bonds, and kept interest rates low. This made stocks look more attractive.
The US Federal Reserve is gently removing its easy monetary policy, but rates of less than 1 per cent still do little to inhibit growth. Meanwhile, central bankers in the eurozone and Japan are still stimulating. Money is fungible, and investors in those areas seek out the best rates they can find, which are in the US.
One player is more powerful even than central banks: the bond market. The normal balancing mechanism of markets would see a pick-up in growth matched by a rise in bond yields, which would damp enthusiasm for riskier assets. After a rise from historic lows after the Brexit referendum, that has not happened. Yields have fallen. This could reflect technical factors, such as central bank buying, or higher demand for bonds from ageing populations. Or it could mean that the bond markets don’t buy the argument that growth is coming. For now the bond market still supports enthusiasm for stocks.
Another easily forgotten factor is corporate earnings. In recent weeks companies have generally revealed healthy growth in earnings and revenues. This can be overstated, but it supports share prices. Low interest rates and rising earnings are lulling investors and pushing down the fear gauge.
How does any of this explain the stampede for tech? While buying at these levels is a risky game, the dominance of Big Tech reflects a different, and less exuberant, calculation than the boom of the 1990s. When growth is scarce, investors will pay more for those companies that have it. Tech companies are growing, with numbers from the bellwether semiconductor groups suggesting more growth ahead. As a market narrows around a few stocks, it is a classic sign of lack of confidence.
Those investors who think stocks are too expensive but will rise further are not betting they can find a “greater fool”. They are betting that rates will stay low, tech earnings will remain more robust than anyone else’s and that the geopolitical noise can be dismissed as just noise.
This is a risky and uncomfortable position but it is sustainable for now. And in his first 100 days, Mr Trump has not upset the applecart.
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