stocks hitting new highs as risk appetite spreading 1843852017

US equity indices posted fresh record highs on Wednesday, and the FTSE 100 is less than 50 points away from its record 7,354 level reached in mid-January. The lead indicators for the markets, including the Dow Jones Transportation Index and the Russell 2000 also scaled to fresh heights, suggesting that this rally is here to stay, even as some economists and analysts’ rush to argue that markets are stretched, volumes are low and valuations are too high.

Market red flags do not mean this rally is over

The latter point is worth noting; we mentioned in an article that we published earlier this week that perhaps stock market valuation methods, such as the P/E ratio, are no longer relevant for the current environment.  P/E ratios may have plateaued at a high level due to a number of factors including international corporates using cash to buy back stock and engage in M&A activity, which tends to boost valuations. Read more on this topic here.

Markets brush off increased probability of a March US rate hike

Interestingly, the stock market didn’t seem concerned by the slightly more hawkish tone from Janet Yellen’s comments to Congress earlier this week. Although she didn’t give any hints as to the timing of the next rate hike, the market has increased its bets that the Fed will hike rates to 1% at the March meeting, the current probability of this at 44%, up from 24% just last week. This has helped to drive the 10-year Treasury yield to 2.5%. Bond King himself, Bill Gross, has said that 2.65% in the 10-year will be the start of a bear market for bonds, so watch this space.

The rise in yields didn’t do much to boost the dollar; instead it was middle of the G10 pack on Wednesday. We think that this has more to do with the widening of risk appetite, for example into commodity currencies like the Aussie dollar and into emerging market currencies, rather than any fatigue with the greenback. The South African Rand was the strongest performer versus the USD on Wednesday, up more than 1.3%. To get a grip on risk appetite, watch the EM FX space.

Trump: a financial market hand grenade

The Russian Ruble was one of the worst performers yesterday, this came after President Trump tweeted that President Obama was too soft on Russia over its invasion of Crimea. What about the Trump/ Putin bromance that has been blossoming and driving the RUB higher? We doubt that it is over, and would imagine that relationship has a long way to run. But it’s a keen reminder that President Trump, rather than valuation measures, are a bigger threat to the stock market rally.

The President’s big test will come on 28^th February, when he addresses the US Congress. If he fails to deliver tremendous, even beautiful, plans on taxes and infrastructure spending then the bottom could easily fall out of the market.

Dutch elections worth watching

Things are heating up in Europe. The Dutch election season kicked off this week, voting takes place on 15^th March. Right now polls suggest that the Far Right leader Geert Wilders is in the lead. If he does win, then this could send a shiver down the spine of European assets, knocking equity markets, driving up bond yields and weighing heavily on the euro. While Dutch elections may not be on everyone’s radar right now, they will be in a few weeks’ time as a win for Wilders could embolden Marine Le Pen’s campaign in France. If she wins in May, then the EU project could start to unravel very quickly. Also of note, former Italian PM Renzi, called for fresh elections to take place in Italy in September; if this is confirmed then it would add to the election risks in the currency bloc this year.

Data is fairly thin on the ground on Thursday, US housing data and initial jobless claims are likely to be the focus on the economic front. Trump’s twitter account, along with the 10-year US Treasury yield, and the expected continuation of this risk rally will divert most of the market’s attention.