Markets rise on trade certainty but valuations stretch as bubble fears emerge
Markets have cheered new US trade deals with Europe and Japan, but analysts warn stocks may be too pricey as signs of a bubble emerge.
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Crisis averted, for now.
US trade deals in the past week have effectively defused the August 1 deadline as a risk for markets, but by themselves aren’t a good reason to buy stocks at these levels.
EuroStoxx 50 futures pointed to a 1 per cent rise in Europe’s benchmark on Monday after the EU agreed to accept a 15 per cent US tariff on most of its exports. Japanese stocks soared to record highs on a similar deal last week, and trade deal optimism helped lift the S&P 500 to a record high on Friday.
Australia’s stockmarket rose slightly Monday before crucial CPI inflation data on Wednesday.
US Treasury Secretary Scott Bessent says the August 12 deadline for a durable tariff agreement with China is likely to be extended in talks in China this week – that deadline may no longer be a risk.
But the simple fact is the MSCI All Country World index has risen about 30 per cent from its April low and valuations are stretched, primarily because investors correctly anticipated these trade deals.
If the trade deals give upside potential for stocks prices from here, one would need to assume that the stock market would have been even higher if not for the trade policy uncertainty this year.
Of course, it’s also a big week for US corporate earnings, monetary policy and economic data.
The US Federal Reserve’s interest rate decision is due early Thursday morning local time. Results from US mega-caps including Meta, Microsoft, Amazon and Apple, as well as US non-farm payrolls data are due before the weekend. A third of S&P 500 companies have reported so far, with a significant 40 per cent raising guidance. An impressive 83 per cent have beaten analysts’ consensus expectations on earnings per share, with those that have beaten estimates doing so by an average of 6.9 per cent.
But at this stage, there’s no sign that stockmarkets in the US and Australia are running out of steam.
Of course, the tariffs of 15 per cent for Japan and the European Union are well below rates of 25 per cent and 30 per cent respectively that the US had threatened to impose.
But they are still a drag on global economic growth and an inflation headwind for the US that is yet to be properly gauged. At this stage, continues to delay US interest rate cuts.
UBS Global Wealth Management chief investment officer Mark Haefele has warned that while the trade deals provide short-term relief, investors should brace for potential volatility ahead.
“The substantial rally in recent weeks has already priced in a lot of potential good news, and investors should prepare for potential market volatility in the weeks ahead,” he said.
Despite the progress on trade, tariffs have risen about sixfold from pre-Liberation Day levels, and “uncertainty remains about the scale, distribution, and second-order effects” of these policies.
Mr Haefele tells investors to “prepare for market volatility” by implementing short-term hedges for those already allocated to equities, but said those who are under-allocated should “prepare to add exposure on potential market dips in the weeks ahead”.
The concerns about market froth come as Bank of America’s Michael Hartnett warned that bubble conditions are emerging.
“Bigger retail, bigger liquidity, bigger volatility, bigger bubble,” he said in a research report, pointing to loosening monetary policy alongside easing financial regulation as key risk factors.
Mr Hartnett, who correctly forecast international stocks would outperform the US this year, noted that the world policy rate has fallen to 4.4 per cent from 4.8 per cent over the past year and is forecast to drop further to 3.9 per cent in the coming 12 months.
This comes as signs of speculative excess emerge across markets.
The Wall Street Journal has reported that online house flipper Opendoor Technologies has surged 377 per cent in the past month, despite a stagnant US housing market. US department store Kohl’s is now one of the biggest stock gainers, despite replacing its chief executive multiple times in recent years.
Of the 33 stocks in the Russell 3000 that have tripled in price since the April market bottom, only six have generated profits over the past year, according to Bespoke Investment Group analysis.
Cryptocurrency prices are also surging, with companies like Trump Media & Technology Group announcing bitcoin treasury strategies worth approximately $US2bn.
The equity risk premium – the gap between the S&P 500’s projected earnings yield and 10-year Treasury yields – is near zero. The extra return from stocks over lower-risk bonds has vanished.
For Australian investors, the key takeaway is that while trade deal certainty removes one source of volatility, stretched valuations and emerging bubble conditions suggest caution is warranted.
The focus this week should be on whether corporate earnings can justify current price levels and whether central bank rhetoric provides any reality check to market exuberance.
“We expect market upside over the coming 12 months, and greater tariff certainty will help support that,” said UBS GWM’s Mr Haefele. “At the same time, after a strong rally and with good news now well-priced, we believe that markets may be vulnerable to volatility in the near-term.”
Originally published as Markets rise on trade certainty but valuations stretch as bubble fears emerge
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