What a solid start to the year it’s been for global stock markets. The US S&P 500 index recorded a series of highs this month, peaking at a record 4,906.69 points on Friday (26 January).
Likewise, the European STOXX 600 index is close to its all-time highs of early January 2022. Alas, the UK’s FTSE 100 index is yet again the global laggard, losing 1.2% since 29 December.
I worry about stock prices
One old City saying reads: “As goes January, so goes the year.” In other words, a strong start for stock markets in the first month helps to deliver positive returns for that year.
However, while other investors’ moods may lift with higher stock prices, I’m worrying a bit. That’s because US stocks — and particularly mega-cap tech businesses — look priced close to perfection.
Therefore, what might burst this latest market bubble, deflating global share prices? Here are four things that give me concern today.
1. The Federal Reserve
In recent years, it appears that markets have danced to the Fed’s tune. Thanks to near-zero interest rates, stock returns were great in 2019, 2020 and 2021. However, the US market collapsed in 2022, driven down by repeated rises in the Federal Funds Rate (FFR) to curb red-hot inflation.
Right now, the FFR is 5.25% to 5.5% a year, but investors expect this to fall to around 4% by the end of this year. Indeed, futures markets are pricing in six rate cuts in 2024. But if inflation remains sticky, then the Fed may cut rates more slowly. I think this might be negative for asset prices globally.
2. Too far, too fast?
In an article published on 24 November, I asked: “Did a massive stock-market rally begin on 27 October?” It turns out the answer was an emphatic yes, with the S&P 500 surging 18.8% since that day’s close.
With US stocks almost a fifth higher than three months ago, I’m anxious that prices have risen too much, too quickly. In fact, I suspect that some of this year’s potential returns were dragged in late 2023, pulled forward by bullish buyers.
3. Elevated valuations
With stock markets having climbed so steeply, I see US valuations looking overstretched right now.
Today, the S&P 500 trades on 22.1 times trailing earnings and offers a dividend yield below 1.5% a year. These numbers don’t look attractive to me, plus they don’t compare well with historical ratings. Therefore, I’m not convinced the US market has that much further to go.
4. Corporate earnings
Then again, one thing that often supports pumped-up prices is higher company earnings. In 2023, earnings growth was weak, but analysts expect it to rebound strongly in 2024. But if these hopes prove unfounded, then this key support for share prices could wobble.
So what do I buy?
When ‘irrational exuberance’ rules markets, what assets should I buy? For me, the most unvalued stocks right now are FTSE 100 shares.
The Footsie trades on a lowly multiple of 10.3 times earnings, delivering a healthy earnings yield of 9.7%. Furthermore, my home index offers a dividend yield of 4% a year, covered over 2.4 times by earnings.
To me, this looks too cheap by far. Hence, I intend to buy British in 2024!
