Investors are being cautioned that the currently elevated US stock market has not yet priced in the risks from surging inflation and remains highly vulnerable to significant spikes in bond yields.
Strong first-quarter corporate earnings reports, combined with market expectations that artificial intelligence could boost the economy, have continued to fuel the strength of US stocks. This has led to the market overlooking risks such as persistently high energy prices and the unresolved US-Iran conflict.
Over the past week, bond yields have risen sharply, with the yield on the 30-year US Treasury surpassing 5% and the benchmark 10-year yield reaching above 4.5%. This shift in market conditions could potentially reshape the landscape and contributed to an overall cautious mood in the stock market on Friday.
After a brief decline in late February following the initial outbreak of the US-Iran conflict, major US stock indices have staged a strong rebound.
Rising benchmark yields typically pressure stock valuations and increase borrowing costs for businesses and consumers. This not only weighs on economic growth and squeezes corporate profits but also makes bond yields more attractive relative to stocks. This effect becomes increasingly pronounced given the current high level of stock valuations. According to data from London Stock Exchange Group, as of Thursday, the S&P 500 index's forward 12-month price-to-earnings ratio stood at 21.3 times, significantly above its long-term average of 16 times. Although this is below the peak of 23.5 times in October of last year, optimistic corporate earnings expectations have only marginally stabilized valuation levels.
Portfolio managers state that the core driver behind the stock market's strength lies in corporate earnings. First-quarter profits for US-listed companies have significantly exceeded market expectations, with a projected year-on-year increase of approximately 28%, marking the largest gain since the end of 2021.
A portfolio manager at Janus Henderson noted, "The market is now showing the beneficial effects of the artificial intelligence investment boom and the resulting productivity improvements," adding that this positive momentum could extend until 2027.
A new wave of enthusiasm for artificial intelligence has driven up related stocks. Massive investments in data centers and various AI-supporting infrastructure have significantly boosted demand for chips. However, valuations in the AI sector are already elevated, and many industry insiders anticipate a potential correction.
Furthermore, a fear of missing out continues to support the stock market rally.
Nevertheless, investors are becoming increasingly aware of various risks and the potential shocks the stock market may face. Due to the uncertain situation surrounding the temporary US-Iran ceasefire, international crude oil prices have remained firmly above the $100 per barrel mark. The sharp rise in oil prices has further intensified market concerns about inflation. The US Producer Price Index for April recorded its largest increase in four years.
In a report issued to clients on Thursday, the Chief Markets Economist at Capital Economics cautioned that the market is not prepared for extreme scenarios in the Iran situation, such as a prolonged closure of the Strait of Hormuz. While the bond market has begun to price in inflation risks, the stock market has not paid sufficient attention to the hidden danger that a prolonged blockade could hinder the economic growth that supports earnings.
The geopolitical crisis in the Persian Gulf and the resulting inflationary pressures could have long-term negative effects.
The Chief Geopolitical Strategist at market analysis firm BCA stated that the Iran crisis could reshape the overall market trajectory for the remainder of the year.
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