A clearer idea of the main drivers of the multi-year US stock market rally provides new insight about its durability and substance. The main causes of the rally can materially change perspectives about the outlook.
Cycles allow for both bulls and bears and provide a focus on the catalysts for a shift between the two. When growth is strong, underlying issues don’t seem to matter. However, once growth has peaked underlying problems can return to a more dominant concern.
After examining attribution, I believe the next down cycle in the US economy is important not to miss. In my opinion, US debt dependence is extreme, and so the degree of fragility in the financial system is far greater than is widely understood.
After the tax reform boom in the US equity market, what will follow to keep up that level of stimulus? Already, there are signs that a US down cycle could be beginning.
There are only a few main macro sources for equity market gains, broadly covered under these four headings.
1. Interest rates
3. Corporate profits
4. Debt (EV/revenues + budget deficit)
Interest Rates have been at record lows for most of the last several years in both absolute and real levels.
However, they have been lower and for longer in both Europe and Japan, and have have little effect on those domestic markets. Also the US stock market has accelerated its rally over the last 2 years as interest rates rose. So its not interest rates.
Revenue growth has been weak and the stock market has massively outperformed revenues/sales, as the chart below shows. So not revenue.
Corporate profits after tax do show some improvement in the last 2 years but have made only a marginal new high relative to 2014/5, so like revenues they have massively underperformed the stock market.
Before tax corporate profits have been even weaker. Failing to make a new high and look sideways since 2012.
It also looks unlikely that many more tax reform bills can help. The tax reform bill clearly made a difference, roughly halving corporate tax receipts.
However, this hit to tax revenue has taken the ratio down to new lows in relation to federal debt. There may not be much room for more corporate tax breaks.