The billion dollar question: what powered the S&P 500’s extended rally, and can it continue?

Jane Fu

Singapore Sales Trader

On Wednesday (22nd August), the S&P 500 index closed at 2861, exceeding its previous all-time high level of 2872 set in January 2018. Since the beginning of 2018, financial market participants have fretted that the 10-year-long US market rally would soon come to an end. Two-thirds of the way into 2018, however, and we see the 10-year US bull market is on track to set a new record high with no signs of collapsing.

Despite President Trump’s strong mandate that is causing trade conflicts with almost all US trade partners, the stock market swiftly readjusted after all trade-related disturbances. The billion dollar question in every investor’s mind is now: what powered the S&P 500’s extended rally and can it continue? We will attempt to explore the drivers behind the prolonged bull run.

Quarterly Earnings

Strong quarterly earnings fully deserve to be the number one driver behind rising stock prices. Eighty percent of S&P 500 component stocks reported surprises in their second quarter earnings releases and 72% have reported surprises on revenue.

According to data compiled by Thomson Reuters, the blended earning growth rate for S&P 500 stocks was more than 24% for Q2’18 and the revenue growth rate was more than 9%. Eighty percent of the companies’ reported earnings beat analysts’ prior estimates. The Q2 earnings gave investors confidence in many different factors since not only was the overall profitability of companies strong, but income growth momentum was also rising.

Enlarge
Source: Thomson Reuters

The sharp drop of the US corporate tax rate from 35% to 21% was the dominant reason for the improvement seen in US companies’ profitability. Many companies enjoyed the extra savings from tax reform and utilised these funds to pay off debts or procure new equipment to expand production.

Strong corporate earnings effectively offset worries from the US declaring trade wars with the rest of the world.

Share buybacks

As mentioned, US companies’ quarterly earnings kept rising, which secured abundant cash flow; a wave of share buybacks has also quietly pushed these returns to the front. Goldman Sachs recently issued a report estimating the total stock buyback this year will reach $1 trillion on the back of tax reforms and strong corporate cash flow. Tech stocks and financial names accounted for most of the buyback amount; Apple, the first US stock to reach $1 trillion in market capitalisation, has cumulatively repurchased 43.5 billion of its own shares in the preceding two quarters. If we look back at Apple’s share price fetching new highs over and over again, we find that this is definitely related to its rather aggressive share buyback footprint.

Enlarge
Source: Bloomberg

As far as the stock market is concerned, share buybacks have always been an important stimulus for stock prices. On one hand they reflect management’s recognition of their shares’ current market value (or even hint that their stocks are undervalued). On the other hand, they give investors more confidence. Apple’s buyback further enhanced investors’ confidence in FAANG technology stocks and attracted more funds into this sector.

Economic Growth

Additionally, strong fundamental growth in the US economy is key component of US stocks’ bull run. US second quarter GDP crossed the 4.1% mark and this rate looks sustainable. Meanwhile, the unemployment rate fell below 4% on top of steady wage growth. Since the beginning of the year, there were on average 245,000 jobs added to the US job market monthly. The promising job market allowed investors to pour more money into the stock market.

What’s next after FAANG

Something worth pointing out is in the past 18 months, technology stocks accounted for the majority of the broad rally. As much as most clients with tech positions enjoyed good profits, realised or unrealised, this remains an alarming sign because every stock has its cycle. What we have observed recently are two clear trends: 1) leadership has shifted from technology stocks to other sectors like consumer staples and health care; 2) investors have started to divert their focus to small-cap stocks.

On August 16, US retail giant Walmart’s share price skyrocketed 10% within in a single day after its earnings topped estimates in many different lines, along with encouraging online sales growth. Walmart ‘s surprisingly good release was not a standalone case. In second quarter earnings, we have observed that consumer-related sectors are doing extremely well. More than 90% of consumer staple stocks delivered above-consensus earnings in Q2, ranked second among all 10 S&P sectors behind health care.

Enlarge
Source: Thomson Reuters

With the ongoing trade tensions between the US and literally the rest of the world still playing out, heavy exporters and global conglomerates may suffer from trade clampdowns or even boycotts by other countries. However, as a consumption nation, the domestic demand within the US continues to be uplifting. Most of the domestically focused stocks have decent space to grow. This has been proved by the Russell 2000 index outperforming the S&P 500 on a one-year horizon, especially in the recent five months after the trade war fire ignited.

Enlarge

A quick word to our readers: as much as we believe that the bull market has more space to run given the strong momentum outlined above, we do wish to bring your attention to sector diversification as the market is moving away from being pushed by a few individual stocks.

You can access both of our platforms from a single Saxo account.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.