With ‘Everything’ At All-Time Highs, Is It Really ‘Too Late’ To Be A Bull?

Just like that, US equities are right back to record highs.

Following an abysmal May dominated by Donald Trump’s latest and “greatest” tariff escalations, the S&P is gunning for its fifth-best month since 2009. For what it’s worth, the index is also looking to log its best first half since 1997.

Unsurprisingly, some folks think this isn’t likely to last, no matter how hard the Fed (and the ECB and the RBA and the BoJ and on and on) tries to prolong the bull market and sustain the expansion.

“It’s too late to be bullish”, SocGen’s Sophie Huynh told Bloomberg on Thursday. “The Fed starts to consider rate cuts, equities should start to reflect slower growth momentum, and investors should start to cut earnings expectations.”

There are a couple of “should”s in there, and the problem for anyone who’s been cautious on risk assets (and especially stocks) at any point during the post-crisis era, is that while central banks have proven to be somewhat impotent when it comes to engineering robust growth and getting inflation sustainably to target, their policy prescriptions have been anything but “impotent” when it comes to inflating financial assets.

Hindsight is always 20/20, but, to speak frankly, the only thing anyone “should” have been doing for the last decade is buying any and all dips or, hell, just buying and holding. In fact, total return indexes for stocks, IG bonds and junk bonds are all at record highs.

As far as stocks go, if all you care about is the prospect of Fed cuts and you’ve decided to make all other concerns subordinate, here are two visuals from Goldman which together give you an idea of what history says you might expect:

(Goldman)

With bonds, it’s even easier to suggest the rally has run too far. After all, we were at 3.20 on 10s a mere ~9 months ago and now here we are just hoping to hold onto 2%. Meanwhile, pricing at the front-end has obviously forced the Fed’s hand.

If you ask SocGen’s Alain Bokobza, it’s too early to bail on bonds (and there’s a double entendre of sorts in there if you look hard enough), despite the risk of sloppy unwinds in myriad crowded rates trades.

“The asymmetry in the Fed’s reaction function against the backdrop of missing inflation has driven fixed income assets to strongly outperform [and] we are at the point at which one may start to worry whether these easing expectations have gone too far, and if there is a risk of sharp unwinds in positioning if data improves”, Bokobza writes, in a note dated Thursday. “While this may be a risk in the short term, we still see bonds staying attractive over the medium term”, he says.

Remember, “Long USTs” was identified as the most crowded trade on the planet in BofA’s latest Global Fund Manager survey.

Read more: Of Equity Bears, Bond Bulls, Tail Risks And Policy Impotence

Bokobza goes on to note that markets are currently pricing in about 110bp in cuts this cycle and “if the data does deteriorate further, the Fed could theoretically ease by another 100-125bp before hitting the zero lower bound.”

(SocGen)

That, he reckons, “should leave some room for further performance before Treasurys run out of road.”

Needless to say, if things got so bad that the Fed was forced to cut rates to zero (or, who knows, below), stocks would likely be in all kinds of trouble, as the US would almost surely be in a recession at that point.

But, Bokobza notes that a lot of what you’ve seen when it comes to falling bond yields, inflation expectations and manufacturing PMIs is down to the trade war. He also flags “persistent negative growth” in semiconductor sales and estimates of global trade volume turning negative earlier this year as signs that the uncertainty is primarily due to the trade conflict. “On the other hand, the services sector data have been resilient”, he writes.

That brings us right back to the same, old post-crisis quandary. With the market convinced that rate cuts and, perhaps, a return to QE, are in the cards, anything overtly positive (e.g., a sudden turnaround in manufacturing PMIs, a quick trade deal, etc.) could prompt the market to start pricing Fed cuts back out.

Therein lies the ultimate irony – while it’s certainly true that a rapid worsening of economic conditions or a further deterioration in the general outlook would risk knocking stocks off their lofty peaks, better data and a quick resolution to the trade war could pose a medium-term risk for both equities and bonds if it prompts the Fed to reconsider cutting rates beyond July and/or pushes yields back up too quickly.