Stockwatch: why there could be more pain ahead for US shares
Analyst Edmond Jackson argues that recent US stock market falls were more than a knee-jerk reaction to the Federal Reserve’s surprise on interest rates. He also assesses the retail landscape in the UK amid a profit warning from one firm.
20th December 2024 12:05
by Edmond Jackson from interactive investor
Does last Wednesday’s change to US interest rate guidance by the Federal Reserve prick at bubble values in US stocks, or help set a healthier base for advances in 2025?
In the UK, the Bank of England’s hesitation to cut interest rates at all just now reflects concern at stubborn inflation. Coincidentally, a terrible profit warning from retailer Shoe Zone (LSE:SHOE) blamed falling consumer confidence since the Budget, plus significant additional costs from the rises in national insurance and living wage because stores will need closing.
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However, Shoe Zone is exposed at the value end of retail, Chinese online sellers such as Shein and Temu are undermining, and where the chancellor did nothing to address, a VAT anomaly that they can exploit.
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The Bank of England notes a genuine risk of stagflation; yet for stock traders that is potentially exciting by way of share over-reactions to profit warnings.
I decided to let Shoe Zone go by, as the business looks cornered and its shares illiquid on a big spread.
US sentiment and fundamentals are at a crux
The US situation is now very interesting. Stock market falls just recently were more than a knee-jerk reaction to the Fed’s surprise on interest rates.
Yesterday just broke a 10-day losing streak in the Dow Jones Industrial Average where you would need to go back to 1974 and 1971 to find 11-day losses. But the Dow had traded up around 250 points by mid-day, only to close just 15 points up or by 0.04%. That is effectively a “fail” by way of rebound, you should expect to see if bullish sentiment is intact. I do not mean to alarm bearishly, just note that this could be an early sign of US stocks forming a top.
Care is needed, interpreting indices, as the Dow largely reflects the “old economy”, while dynamism is in the Nasdaq. Yet this and the S&P 500 closed 0.1% lower yesterday.
Not to get overly short term, Jeremy Siegel, the Wharton School professor of finance, says the US sell-off is “healthy” and that the Fed’s cautionary projection gives investors a “reality check...that we are just not going to get as low interest rates”.
Mind, Siegel is quite a perma-bull, which in due respect has worked very well on US stocks since the 2008 crisis.
US economic significance is shown by its listed companies constituting around 25% of global economic output. It enjoys superior performance, growing at 2-3% this year. Productivity is superior, also labour supply has been below demand, which has ensured real wage growth and thus averted predictions of a US recession.
- Record demand for US shares triggers ‘sell’ signal
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Meanwhile, China is caught in a deflation trap, not dissimilar to Japan in the 1990s, as a result of excess construction. It has passed on its status of locomotive of the global economy to the US. Despite temporary boosts to its stock market by talk of “big bazooka” stimulus measures, any upshot has been fleeting, hence this also affects Asia.
Europe is constrained by higher costs and regulation, which have worked against it as a “mercantilist” exporter. For example, its cars and chemicals are no longer globally competitive. The UK has elected a tax-raising government with such effects already apparent.
Unsurprisingly, the US attracted investment capital which has also strengthened the dollar and pushed US shares to valuations in the highest 2% range of yardsticks over the last 140 years. Technology behemoths behind the “Magnificent Seven” have also meant a terrific concentration in the stock market.
Typically, valuations get pricked when financial liquidity changes adversely, hence last Wednesday jolting expectations. The US has been on a merry role where the Fed issued Treasury bills and “reverse repo” actions injected money into the financial system that helped boost asset prices. Barring another crash, this seems unlikely to resume.
Early in 2025, Congress will need to raise the US debt ceiling – debt being a favourite instrument of Donald Trump – to keep the economic show rolling by way of government spending.
President Trump’s early actions will also be critical for stocks
Bulls figure that the imminent new US Treasury Secretary – a Wall Street financier who once worked for George Soros – will temper Trump’s whacky election pledges aimed to secure votes.
Yet Scott Bessent is signed up to Trump’s “America First” agenda “to stop unfair trade imbalances”. Tariffs are a tax that lowers overall prosperity given that they lead to trade wars and investment being held back – a bad scenario for export-led European and Asian economies also.
History shows the June 1930 Smoot-Hawley Act was in part responsible for tipping the US and global economy into depression.
Allegedly, if Trump does half what he proposes, it will result in tariffs equivalent from the beginning of the First World War to the end of the Second World War. Bessent has some reining in to do.
Trump also wants to deport illegal immigrants, but it would seem that employers then need to raise wages, which is hardly needed versus inflation at 2.7% and rising.
He seeks to cut government expenditure; good structurally but it implies job losses and reduced incomes. One estimate is that even if $500 billion cuts are made – a quarter of Trump’s target – it could lead to a 2% fall in GDP.
You get to appreciate why the actions of the new Trump administration will be critical for investing in 2025, albeit very hard to conjecture right now.
Perhaps a saving grace is how Trump has enjoyed being judged partly by stock market performance; so if the market continues to slide in the new year, it will temper much radicalism.
Yet “Make America Great Again” amounts to economic nationalism and Trump’s cabinet will have to live in a world where he believes international trade is a zero-sum game and deficits are like losses on a corporate balance sheet.
Unless support kicks in soon, an early 2025 scenario is therefore continued downside in US stocks as capital preservation becomes foremost in investors’ minds.
That could, however, prompt the Fed into cutting interest rates in the way it has repeatedly shown that it manipulates asset prices as an aid to overall growth, much like UK politicians are apt to prop up the housing market. It is why the Fed gets criticised for a political role beyond a traditional central bank mandate.
UK shares may be cheap but suddenly we see reasons why
Similar to the US, the Bank of England is struggling with inflation after serially under-estimating how it re-established from excess monetary stimulus. Core UK inflation rose to 3.5% in November; house prices by 3.4% in the year to October and rents by a whacking 9.1%.
Meanwhile, last Wednesday revealed UK factory orders have slumped to the lowest level since peak-Covid in 2020.
It will be interesting to see how Christmas retail trading statements pan out. In discretionary spend, it appears Black Friday just got extended and some prices have continued to fall as if new year sales are being brought forward.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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