Donald Trump tweeted Monday after a G-20 meeting with Chinese President Xi that relations between the two countries had made a big leap forward. Stock investors seemed more than willing to buy this story. Shares rose sharply on Monday. The S & P 500 index, which was in the red for the year less than a month ago, has risen above 4% for 2018.
Many on Twitter, however, pointed out that Trump's tweet seemed to ignore the story. China's most famous advance in the 1950s resulted in the deaths of tens of millions of people in the famine. More recently, trade talks between China and the United States have been more "one step ahead, two steps back" rather than big leaps. More importantly, it is not clear that a trade deal with China can give a lasting boost to the stock market. This is because the main market problems are growth and interest rates, which will not be solved by any trade agreement with China. In fact, for investors, this could aggravate their problems.
Share price rises combine two things: profits and what investors are willing to pay for them. The first half of this equation is good news. S & P 500 corporate profits are expected to grow 10% next year. The problem is the second half, namely the price / earnings ratio.
As profits grow, earnings growth will be down, by almost 25% this year. This is usually bad for stock prices. Jim Paulsen, chief equity strategist at Leuthold Group, said in a note on Monday morning that a one-point drop in the economic growth rate tended to lead to a 2.2% decline in P ratios. / E. US GDP growth is expected to fall to 2.6% next year, from 2.9% in 2018 to 1.9% in 2020, according to Bloomberg's latest forecaster survey.
In addition, interest rates, the kryptonite of the stock market, are rising. And a trade deal with China is likely to remove one of the most feared obstacles in the economy. This could lead to even higher interest rates. The inverse relationship was about one-third, which means that the P / E ratio of the market is reduced by about one-third of the rise in long-term interest rates. And, as Paulsen points out, the price-earnings ratio of the market has fallen by about 20% last year, the long-term interest rates – the average between the yield of the 10-year and 30-year Treasury bonds years – from around 2% to 3.2%. This rate should be above 3.5% by the end of next year, according to the Bloomberg survey, a gain of about 10%.
If you combine them, this would lead to a 5.4% slowdown on the S & P 500. Profit margins, another long-term price rider for stock prices, are also expected to come under pressure next year. All of this most likely means that next year's expected earnings growth of around 10% will only result in a stock price rise of 4.6%, or not much more than the 4.4% average corporate bond yields currently. The most likely steps for the stock market in the future will be those of the baby. The jumps, at least for this bull market, have already been crossed.
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Stephen Gandel is an editorialist of Bloomberg Opinion, specializing in banking markets and equity markets. He was previously deputy digital editor of Fortune and blogger in economics at Time. He also covered the finances and the housing market.
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