Wall Street’s latest guessing game is trying to pick the market top

Another day, another bunch of records for the US share market. Investors’ renewed love affair enthusiasm with tech stocks, combined with lift in the oil price has hoisted both the Standard & Poor’s 500 index and the Nasdaq Composite to new all-time highs.

Meanwhile, another record was trampled in trading overnight, with the S&P 500’s tech sector index finally breaking its previous record set back in March 2000, at the giddy height of the dot-com boom.

Instead of displaying any signs of vertigo at the US share market’s relentless rise, investors are uncannily calm. The CBOE Volatility Index, or VIX – known as “Wall Street’s “fear gauge” – is trading around historically low levels.

One reason investors are tranquil is that markets have been storm-free for an extraordinarily long time. The S&P 500 has gone for more than a year without suffering a 5 per cent decline, let alone experiencing the 10 per cent drop which would qualify as correction. This is only sixth time since 1950 that the S&P has gone 12 months without a 5 per cent dip.

But it’s not only the US share market that is unusually tranquil. Major European and Asian share market benchmarks have demonstrated a similar calm in 2017.

Indeed, it’s been close to a quarter of a century since all three indexes – the S&P 500, the MSCI Europe and the MSCI Asia-Pacific (ex-Japan) – have gone so deep into a year without suffering at least a 5 per cent pullback.

These relentless share market advances have spurred a new guessing game among analysts: trying to predict when the market will peak.

The bulls argue that global equity markets will continue to rise for at least another year, because they’re being buoyed by the sea of liquidity from the world’s major central banks.

Together, the US Federal Reserve, the European Central Bank and the Bank of Japan have pumped more than $US13 trillion ($16.3 trillion) in liquidity into global financial markets since the financial crisis, with $US1.5 trillion flowing in so far this year. It’s this liquidity, they say, that has driven the bull market in equities that began back in March 2009.

They argue though the US central bank has signalled that it will soon start whittling back the size of its $US4.5 trillion balance sheet, any selling by the Fed will be swamped by the ECB and the BoJ as they continue their aggressive bond-buying programs.

However, even they concede that this situation won’t last forever. Although the ECB has promised to keep buying large quantities of bonds until “at least” the end of this year, it is expected to announce in September that it will slowly wind down its bond-buying program over the course of next year.

This means that there’s likely to be a dangerous tipping point in the third quarter of 2018 when US Fed is selling more bonds than the ECB and BoJ are buying.

They believe that it’s only at that point – when the big three central banks are draining liquidity out of global financial markets for the first time since 2008 – that the global share market rally is in danger.

But other analysts believe this is overly optimistic. They point out that long-term bond yields are already rising in anticipation of less monetary largesse.

After ECB boss Mario Draghi hinted at reduced stimulus last month, the yield on German 10-year bunds jumped from 0.25 per cent to 0.54 per cent.

They also believe that US equity investors are clinging to the hope that US President Donald Trump will be able to push deliver on his promise to slash corporate taxes and boost infrastructure spending, despite the Republican’s failure this week to repeal Obamacare.

This optimism is helping to drive the rally in tech stocks, as investors hope that Trump’s tax reforms will allow the big US tech companies to repatriate their huge offshore cash hoardings, and to use the money to reward shareholders with higher dividends and share buybacks.

As a result, they believe that the tipping point for markets could come sooner than investors are expecting.

In a recent note, Bank of America strategist Michael Hartnett warned that “the most dangerous moment for markets will be when rising rates combine in three or four months’ time with an inflection point in corporate profits”.

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