As Stock Prices Peak, Markets Begin to Fear Looming Threats

(Associated Press) With the U.S. economy humming, corporate profits flowing and stock prices peaking, investors on Wall Street are beginning to pose an anxious question: Is it all downhill from here?

Financial markets are always trying to set prices now for where the economy and corporate profits are likely to be in the future. And even though readings across the economy are still at eye-popping levels, investors see some areas of concern.

New variants of the coronavirus are threatening to weaken economies around the world. Many of the U.S. government’s pandemic relief efforts are fading. Inflation is raging as supplies of goods and components fall short of surging demand. And the beginning of the end of the Federal Reserve’s assistance for markets is coming into sight.

So far, investors have largely put aside nervousness — broad measures like the S&P 500 and Nasdaq composite are hitting record highs. Major stock market averages, in fact, have nearly doubled since bottoming in March 2020.

The U.S. recovery from the recession is proceeding so quickly that many forecasters estimate that the economy will expand this year by roughly 7%. That would be the most robust calendar-year growth since 1984.

Outside the U.S., too, economies are showing sustained growth. The Chinese economy, the world’s second-largest, has slowed sharply from last year, though Beijing said it grew nearly 8% in the April-June period. And among the European countries that use the euro currency, growth for 2021 is expected to reach a brisk pace of nearly 5%.

Still, some sharp moves underneath the stock market’s surface and across other markets show newfound hesitance and anxiety about the potential economic threats. Yields on longer-term U.S. government bonds have sunk, for example, while stocks of companies most closely tied to the strength of the economy have slumped.

For now, many voices on Wall Street see the nervousness as merely a blip: They are forecasting stocks and bond yields to rise through the year as the economy and corporate profits continue to grow. Many factors are behind the recent shifts in markets, particularly the sharp drop in bond yields, including some technical ones that likely worsened the swings and may be short-lived.

But some of those same analysts also acknowledge that the shifting signals in markets may be an inflection point following months of gangbusters performance and raging optimism. The fear isn’t that economic growth may slow. It’s that any one of threats to the economy will weaken growth too much, too quickly and perhaps even derail the recovery from the pandemic recession and puncture corporate profits.

“We don’t see it stalling out or reversing, but it’s clearly aging,” Rich Weiss, senior vice president at American Century Investments, said of the economy’s recovery. “We have this whole deceleration theme going on that ‘The Best Is Yet To Come’ is not the case anymore. We’ve definitely peaked.”

Asked why investors would worry about a slowdown when growth rates look so high as to be unsustainable, Weiss suggested that uncertainty can often lead investors to consider a worst-case scenario.

“The unknown of what you’re going to do looms large,” he said. “We’ve been riding this humongous reopening economy and reflation trade. Yes, it’s going to slow down, but what is it going to slow down to? If the job market is still weak, do we slow down to something on the order of 4% to 5%” economic growth, “or does it slow down to 2%? That would be a negative surprise that could roil the bond markets and the stock markets.”

Concerns first emerged earlier this year in the bond market, which has the reputation of being more rational and sober than the stock market.

The yield on the 10-year Treasury, which moves with expectations for economic growth and for inflation, had shot above 1.75% in March after more than doubling in four months. Optimism was rising that life would return to normal as the economy reopened and COVID-19 vaccinations rolled out. But that also fueled worries about sharply higher inflation.

The 10-year yield, though, dropped below 1.25% last week. The months-long drop came as investors fell more in line with the Fed’s insistence that high inflation looks to be only temporary. The slide accelerated after a couple of reports that showed economic growth remained strong but not quite as powerful as Wall Street expected.

The stock market, which had been gliding to record highs, dropped nearly 1% one day last week. The decline was modest but enough to cause some analysts to suggest that stocks were finally paying attention to the signal from the bond market.

Instead, the S&P 500 quickly resumed setting records, the latest on Monday. That’s one of the confounding things for David Joy, chief market strategist at Ameriprise.

If the bond market is signaling worries about upcoming economic growth, Joy said, it’s surprising stocks have performed this well. The same goes for “junk” bonds, which are those issued by companies with weak credit ratings. And corporate bonds should be offering more in yields over Treasurys than they are now.

“The bond market historically has often provided a good early warning signal,” Joy said. “I don’t know if that’s the case this time, necessarily, because we don’t really know what’s driving rates down.”

Besides the worries about peak growth and virus variants, analysts point to other possible reasons for declining yields. They include buying of Treasurys by investors from countries where rates are even lower, pension funds shifting some of their investments from stocks into bonds and a rush of traders simultaneously getting out of bets for rates to keep rising.

Though the S&P 500 is close to its all-time high, some market watchers say movements within the stock market have also shown signs of concern.

In the past two months, the synchronized moves higher for many areas of the market on flourishing optimism have broken down, say strategists at Deutsche Bank. While big U.S. stocks continue to inch higher, smaller stocks in the Russell 2000 index have stalled since peaking in March — and those companies’ prospects are more closely tied to the economy.