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One commonly-cited catalyst for a crash is that Biden is expected to raise the corporate tax rate to 28%. When Trump cut the rate from 35% to 21% in 2017, this was regarded as being a key factor in the 2017 to early-2018 equity market rally. There is evidence that since the 1990s, increases in equity market valuation have been substantially driven by FOMC decisions, so the Federal Reserve clearly has enormous power to pump the market, and there is no near-term sign of this power facing any challenges. US investor sentiment is clearly exceptionally strong, which is a bit confusing given that the real economy is in tatters, US politics is in gridlock, and the 2020s look to be the pivotal decade in which China will overtake the US as the leading world power. Cliff Asness runs AQR, one of the largest quantitative investment managers in the world. This is constructed from public company earnings forecasts (sourced from investment bank research reports). International equities don’t offer the same breadth of investment possibilities, particularly in the technology sector.
Traditional alternatives like fixed income products now offer negative real yields. Federal Reserve data shows that the US personal savings rate is at levels that haven’t been seen since the 1970s. The reason for this is that people are stuck at home with little to spend their savings on, and the US government is handing out stimulus cheques and other forms of income support with wild abandon. Fixed income products are exposed to this risk in a way that equities mostly are not. Personally I’m looking at rotating some of my own savings into international equities (particularly mainland China), and exploring opportunities to earn high yields in the crypto space. Furthermore, with Federal Reserve money creation also at extremely high levels, and big federal spending expansion expected, there is an elevated risk of inflation. We also see retail enthusiasm spilling over into the crypto markets, where Bitcoin, Ethereum and Dogecoin have been rallying hugely as money pours into these highly volatile assets. In my view it is completely possible that equity prices just continue to grow for years to come, even in defiance of the fundamentals, in a pure Keynesian beauty contest fuelled by institutional investors seeking yield and by easy money from the Fed’s low interest rate policies.
However, this is not necessarily a 100% convincing argument: for example, you could counter that if the US authorizes $2k stimulus cheques, that will provide a second wind to the retail inflows and push the markets to even greater heights. Whatever you think about the valuation of these tech companies, I think it’s important to own a bit of them, even if for no other reason than to hedge the “AI risk” that software continues to eat the world, and actually automates you out of a job! Perhaps. Nonetheless, I think it may be worth downweighting the US a little bit at this point. The increased use of options may partly be caused by new fintech entrants like Robinhood that make it easier than ever for retail clients to begin option trading. Retail investors characteristically like to invest in products with lottery-like payoffs: i.e. negative expected return, but with a low-probability possibility of a huge upside. Retail investors are making up an increasing amount of the market. The outlook for the US stock market looks unusually poor. A lot of these savings are ending up in the stock market. Although several alarm bells are ringing, and valuations look a bit overheated, it’s not at all clear to me that there is any immediate danger of a huge stock price crash.
