One perennial truth about people who work on Wall Street is they worry a lot, and the only thing that changes is whatever is worrying them. Here’s what’s currently keeping some seasoned finance veterans awake at night.
The market looks expensive. “Valuations in U.S. equities look stretched; that’s been a pretty consistent signal in our models for a while,” says Stephen Wood, chief market strategist at Russell Investments in New York. “We think the economic fundamentals in the U.S. are good, but we wonder whether they are good enough to support current valuations in U.S. equities.”
[See: 9 of the Market’s Best Growth Stocks.]
The current valuation of the Standard & Poor’s 500 index is considered to be well above its long-term norm based on the price-earnings ratio, the value of stocks relative to their earnings. The ratio now stands at more than 25 versus a long-term average of around 15.
But that’s not all. A more sophisticated measure also points to stocks being pricey. The cyclically adjusted price-earnings ratio was developed by Nobel laureate Robert Shiller to use inflation-adjusted earnings of stocks over the preceding 10 years. This metric also goes by the name the Shiller P/E.
The CAPE ratio is about 29.5, which is higher than at any point apart from the tech bubble of 2000 and just before the crash of 1929. Much lower stock prices followed both periods.
Rising inflation. “Inflation has been trending up, and it is pretty close to the Fed’s target,” says Lakshman Achuthan, co-founder of the Economic Cycle Research Institution in New York.
Rising inflation tends to nudge the Federal Reserve toward raising the cost of borrowing more than it otherwise would. But in this case, the situation could be exacerbated.
“When you look at underlying inflation pressures, they are at their highest rate since 2008,” Achuthan says. “Despite some recent noise in the data, inflation pressure has not retreated at all.”
The problem is that inflation could spiral above the Fed’s well-known 2 percent target, forcing the central bank to raise interest rates both quickly and a lot. Such a move could rattle financial markets and send stock prices lower.
Tax policy changes. The Trump administration has promised major changes to the tax code, including a desire to slash the corporate tax rate from 35 percent to 15 percent. That would put the U.S. more in line with business tax rates in other leading economies. But progress on making any tax changes has been slow.
[See: 7 Dividend Stocks to Benefit From Trump Tax Changes.]
“The longer you push forward the tax changes, the more companies will have to operate under the current regime, and they may decide to do business in other countries instead of the U.S.,” says Steven Blitz, chief U.S. economist at TS Lombard in New York. Eventually, companies may tire of waiting for Washington to act. They would then presume that taxes won’t get cut and respond accordingly. That would mean lower spending on investments inside the U.S., which would probably be bad for stocks.
Oil prices. “When you look at equity and fixed-income markets, people have been lulled into this false sense that oil is going up,” says Peter Tchir, managing director of macro income strategy at Brean Capital LLC in New York.
“I believe people have misread Trump when thinking about the oil market,” Tchir says. “He is good for U.S oil independence, but not for the oil price.”
Lately, the price of oil has fallen from $54 a barrel to about $45 since February. While energy independence will encourage U.S. oil production, that won’t necessarily benefit all oil companies. That’s because the increased output associated with energy independence will mean lower prices and reduced revenue per barrel.
Tchir warns that a sizable part of the high yield, or junk debt, market is related to energy companies and dependent on oil prices. If his worries materialize, junk debt could take a beating, which would mean lower prices for high-yield securities, including those held in the SPDR Bloomberg Barclays High Yield exchange-traded fund (ticker: JNK).
China syndrome. China’s economic health also worries Tchir. “China’s demand for commodities seems to be decreasing, and there is increasing concern that the growth story is faltering.”
That would be bad for global growth and hurt earnings growth as well.
[See: The Best Energy Stocks to Buy for 2017.]
One thing to note: When Wall Street stops worrying, you should start. That’s because bad things often follow stock market euphoria, such as the rush to buy tech stocks in 2000, prompting the dot.com bubble that burst shortly afterward.
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5 Things That Worry Wall Street Experts originally appeared on usnews.com
