US Stock Rally Fueled by Unusual Factors

US Stock Rally Fueled by Unusual Factors

European stock markets took encouragement from across the pond and rallied as US markets greeted the beginning of earnings reporting season with an extension of Friday and Monday's rally to record highs. 

Traders at the NY Stock Exchange
Traders at the NY Stock Exchange iStock

After the S&P 500 broke to a new record high on Monday, it was the turn of the Dow Jones Industrial Average to set a new all-time record on Tuesday. The second quarter earnings reports began as they traditionally do, with an early report by aluminum giant Alcoa, which posted a profit that beat analysts' estimates. Alcoa stock jumped to a two-month high. 

The enthusiasm among investors wasn't for Alcoa alone. While most analysts expect to see a fifth consecutive quarter of corporate contraction in this earnings season, that didn't seem to dampen the spirits of investors buying at or near highs and driving the S&P 500 up another 0.7 percent to 2,152.14. Alcoa's positive news came after a very positive jobs report on Friday and growing consensus that central banks will coordinate policy to limit the fallout from Brexit, whenever (and if ever) it actually happens. 

Wednesday morning saw some fluctuation in US stocks just below the new highs. Meanwhile, European and UK stocks rose as the succession of Theresa May as the new prime minister was greeted with optimism that Brexit will not devastate the global economy.

The latest rally in US stocks is fueled by some unusual forces. First, the strongest advancers are stocks that analysts typically find boring and not very good for generating long-term growth, particularly utilities, phone companies, and consumer staples firms. Not exactly as exciting or cutting-edge as electric cars or medical devices. 

Part of the reason those ho-hum stocks are getting so much buying is because they are seen as safety investments. In the face of multiple uncertainties, including Brexit, record-low bond yields, and weak or non-existent inflation, investors looked to these firms because people are always going to need to make phone calls and do their laundry. By comparison, US Treasury yields are at record lows and while they remain safe havens, they are less lucrative than slightly more risky safety stocks.

However, this unusual way in which US markets have climbed back from their February lows is itself worrisome. Consumer staples and utilities are supposed to grow slowly and steadily while being relatively free of massive drops. They are what are known as defensive stocks, investments that may not make huge gains, but also won't suffer huge losses. 

What remains to be seen is whether other sectors take over from defensive stocks in pushing the markets higher, or if they stall out while the defensive stocks come down to prices more in line with their fundamentals. In a way, it's a race to see if a bigger bubble (the financial and health care sectors) can take over before this unexpected one pops. 

With European and Asian stocks looking promising as Theresa May forms a new government in the UK and Shinzo Abe moves forward with stimulus plans, US stocks may face some competition as the best place for investors to put their money.

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