A former Federal Reserve economist pointed out that investors have already concluded that the Fed will provide a safety net for the economy.
Ed Yardeni, a former Fed economist and senior Wall Street strategist, believes that the record breaking rally in US stocks is far from over.
Despite increasing concerns among investors about the narrow market rebound, overvaluation of large tech stocks, and signs of economic slowdown, Yardeni found solace in the sustained outperformance of US stock returns.
The following are several reasons suggested by Yardeni in a report to clients last Sunday:
Analysts' forward-looking earnings expectations hit a historical high last week, indicating that the market rally is backed by the most important factor - profits. Analysts now have an annual EPS for the S&P 500 index of 261.74 US dollars. Yardeni said: "All of this is based on our assumption that a recession is unlikely to occur in the short term, especially since the Fed will lower interest rates as necessary to avoid a recession."
Although the rise of the US stock market is mainly driven by a few companies, Yardeni believes that the improvement in profit breadth should lead to an improvement in market breadth. In the week of July 5, the proportion of companies in the S&P 500 index whose three-month expected yield changes were positive rose to 83%, setting a new high in the bull market. This indicates that the market should expand.
Although the expected P/E ratio of the S&P 500 index is about 21 times, the median expected P/E ratio of the index is only 17.8 times. Yardeni said: "We believe that the broad market is not overvalued and may rise before the end of this decade under the combined effect of better returns and higher valuation multiples."
Yardeni expects the S&P 500 to achieve steady earnings growth from now until the end of this decade, with EPS for the index reaching $250 this year, $270 next year, and $400 by the end of the decade.
Artificial intelligence is an important component of Yardeni's optimistic outlook. He pointed out that Corning raised its second-quarter performance guidance, proving that the prosperity of artificial intelligence will spread to other companies. After announcing that its optical connection products were stimulated by generative artificial intelligence technology, Corning's stock price soared 10%.
Yardeni said: "This proves the authenticity of the artificial intelligence story. Many companies are benefiting from artificial intelligence."
As to whether US stocks will relive the narrative of the 1990s Internet bubble through artificial intelligence, Yardeni believes that some aspects look similar, but if the economy and the market deteriorate, the Fed may eventually cut interest rates.
Yardeni said: "When we compare the market with the late 1990s, there is a sense of déjà vu. I think the situation can be described as a slow melt-up phase."
Melt-up refers to the phenomenon that investors rush to buy due to the herding effect of not wanting to miss the opportunity of a stock market rally, leading to more and more bulls in the market, super optimistic market sentiment and continuous acceleration of the market to rise. This concept was proposed by Yardeni in a blog article in 2016.
Yardeni said: "In the past few weeks, even under disappointing economic indicators, the market continues to make new highs. I think this is because investors have come to the conclusion that they don't have to worry too much about economic slowdown or even recession, because if that becomes a major risk, the Fed will act quickly to lower interest rates."