Commentary on Political Economy

Wednesday 20 March 2024


 Wall Street stocks are not caught up in a 1990s bull run

Bhanu Baweja is chief strategist at UBS Investment Bank Bhanu Baweja · Mar 20, 2024

The intellectual anchor for the equity rally that began after the US Federal Reserve ended its hiking cycle in January 1995 was provided by Alan Greenspan when the then chair of the central bank extolled improved productivity.

The Fed is close again today to a dovish pivot and once again forecasts of a productivity tipping point are driving equities higher — this time from the spread of artificial intelligence.

Unsurprisingly, comparisons to the 1990s rally are ubiquitous. If there is debate, it’s on where on that decade’s timeline we presently sit.

Some make aggressive, bullish claims of being in the early stages of the rally. Others warn we’re deep in a bubble. The data doesn’t back either of these extreme views.

The 1990s bull run saw two phases: a steady climb from early 1995 to mid1998, through which returns across sectors were balanced, followed by an explosive, narrow rally from late 1998 to early 2000. Today’s sectoral performance patterns, narrow market leadership and valuations resemble the second — bubble — phase.

Stocks considered defensive are lagging behind. Those more exposed to cyclical turns in the economy, particularly techs, are prodigious winners. The 10 largest stocks make up 34 per cent of the S&P 500’s return over the past year, higher than at any point in the 1990s.

The S&P 500’s cyclically adjusted, price-to-earnings ratio at 34 times stands at the 96th percentile of the last century’s distribution — not far from 44 times, or the 99th percentile, in March 2000.

However, the quality of the companies could scarcely be more different. Today, high valuation multiples are being ascribed to companies that yield higher realised income through steady dividends and buybacks.

Unlike the 1990s, both equity volatility and relative demand for downside protection through options are low, signalling confidence in earnings and free cash flow. Yet, investors aren’t indiscriminately euphoric.

Stocks with smaller market capitalisations have seen little joy so far whereas they strongly outperformed in the latter stages of the 1990s rally. Some 133 IPOs a year have come to US exchanges after the pandemic compared with 475 a year between 1995 and 2000. So it’s unlikely there’s a bubble ready to go pop. Many investors take this to mean that the market has a clear runway for another multiyear spell of supernormal returns.

We disagree. The hope is that AI will provide a major productivity lift, delivering an Eden of high growth and low inflation, but US productivity growth has annualised sub-1 per cent post-Covid compared with 2.4 per cent over the five years to the first quarter of 2000. Of course, it’s possible that a major productivity lift is just around the corner.

If tech companies were uniformly bullish about future demand, though, we’d have expected to see strong investment growth by these companies. The evidence is underwhelming. Software capital expenditure grew at 21 per cent a year between the first quarter of 1995 and same period in 2000. Post-Covid, it has grown at just under half that pace. At 2 per cent a year, research and development capex is growing at roughly a quarter the pace of the late 1990s.

Clearly, some tech companies are making large investments but this hasn’t moved the needle at an aggregate level. Nor do we see much optimism in future capex intentions, orders for computers and electronics products or global semiconductor sales.

Away from tech, the broader US context is also different; the international context only more so. On most metrics the US economy is in late-cycle, a vantage point from which equity returns have historically been mediocre.

Globalisation is in retreat while the 1990s saw it at its peak. Global trade grew 2.5-3 times faster than global growth then, lifting earnings. China was entering its strongest growth phase at the turn of the millennium but is searching for a growth model today. Should the largest US stocks fail to deliver on earnings, there is little strength in the global economy to get the cycle going again.

It is true that, some similarities notwithstanding, today’s situation isn’t the anatomy of a 1990s-style bubble. Equally, we don’t have the conditions that support a sustained equity bull run.

The equity risk premium — the returns sought by investors in stocks over bonds — has only been lower twice in the past 100 years: just ahead of the Great Depression and around the Nasdaq bubble. We don’t expect a repeat of that mania and prefer bonds to equities over the coming year.

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