October 11, 2018 / 6:46 PM / 2 months ago

Breakingviews - Markets are finally getting back to basics

A trader looks up at a chart on his computer screen while working on the floor of the New York Stock Exchange shortly after the market opening in New York July 11, 2013. REUTERS/Lucas Jackson

NEW YORK (Reuters Breakingviews) - Blind faith in U.S. stocks may be giving way to the facts on the ground. A slump overnight slowed on Thursday, partly thanks to a tame U.S. inflation report. Yet American equity valuations are high, trade tensions and interest rates are rising, and earnings season is under way. There’s plenty for investors to react to.

Six months of scarcely interrupted technology-led gains took the S&P 500 Index to an all-time closing high on Sept. 20. That also marked the longest bull market on record by some measures. That changed in recent days, with the benchmark down 3.3 percent on Wednesday and global markets following suit. By early Thursday afternoon in New York, the S&P 500 was down another 1 percent. The yield on 10-year Treasury bonds moved lower again, after peaking above 3.2 percent a few days ago.

That’s a fairly normal pattern for investors taking a breather – or a risk-off trade, as they like to call it. The Federal Reserve, led by Jerome Powell, is slowly but steadily increasing short-term interest rates. That reflects a decade of economic growth, a tight labor market with unemployment below 4 percent, and somewhat strengthening inflation, although the pace of consumer-price increases eased to 2.3 percent in the year to September, Thursday’s report showed.

President Donald Trump told Fox News on Wednesday he thought the Fed was “going loco” and raising rates too quickly. However he also suggested to reporters that the market selloff, which he called a “correction,” was overdue. That may be closer to the mark.

Third-quarter earnings season is underway in the United States, too, with 24 of the S&P 500 having reported as of Thursday, according to Refinitiv data. Economist Robert Shiller’s cyclically adjusted price-to-earnings ratio stretched to 33 times in September, suggesting valuations at their richest since 2001. That means investors ought to be sensitive to any signs of a slowdown in strong corporate profit growth.

Then there are the clouds in the global picture, from the U.S.-China trade spat to signs of problems – and investor skittishness – surrounding certain emerging markets. If stocks are priced for perfection, even the faintest shadows can become a reason to sell them.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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