There is of course another way to read it, however, as the data from the US is increasingly mixed. And, with the Fed more concerned with keeping the bull market inflated than things like inflation, there remains a risk that it is and has been for some time, behind the curve.
From an equities point of view, this is where the problem come in, because valuations are fairly rich and, on average don’t seem to be factoring in much possibility of a slowdown.
In a recent note by Societe Generale’s Cross Asset Team, the bank makes the point that, based on cost of capital which it says is almost two standard deviations below the long-term average, the absolute valuation of the US equity market is expensive.
On a relative basis, however, Societe Generale said, US equities remain in fair-value territory relative to US treasuries. This could change however, should earnings growth expectations not be met. And, at present year-on-year earnings growth forecasts are still predicting double digit growth in both 2017 and 2018.
While such forecasts are notoriously optimistic and tend to be revised lower over time, double digit growth in 2017 seems unlikely, especially given that earnings were flat in 2015 and are likely to be so again this year.
“A combination of flat earnings growth in 2017/2018 and a US treasury yield at 2.25% should lead to re-allocation from US equities to government bonds” SocGen writes. And, should this happen it could trigger a market correction.
While not necessarily a base case scenario, that it does not seem to be priced in is worth noting, especially as the country heads into what is already a tumultuous election cycle.
