Record unemployment + global economic shutdown = all-time stock market high’s? That can’t be right, can it? How could our economy, at least on the exterior, seem like a pile of rubble, yet we continue to see the market soar to new heights?
Before we delve into why this may be happening, let’s take a moment to reflect on what the stock market truly entails. Equity markets are built on forward-looking assumptions. When you make the decision to invest in a company, you are not buying it for today’s price, but what it will be worth tomorrow. So when we compare today’s economy with tomorrow’s recovery, we can begin to understand why people have been excited to buy more equity.
But… All-time highs?
It may be possible to wrap our heads around how we have gotten back to the high-water mark pre-pandemic, but why are we still climbing? Here are three factors that I think are most important.
Low Interest Rates
Pre-pandemic we went through a period where we dealt with rising interest rates, then a period of plateau, followed by a brief stint where the rates began to slightly decline. All this movement was in search of finding the proper neutral rate, where the economy could grow at just the right speed without stalling or growing too quickly. We had climbed to new highs in February prior to the pandemic striking. After news of the outbreak first broke, the Federal Reserve quickly slashed interest rates back to close to all-time lows. Low interest rates generally equate to more valuable stocks. This has supported an increase in equity values. With interest rates not having much room to go lower and a Fed determined to push for higher inflation, at some point we will begin to see higher interest rates again, though probably not any time soon.
A Rising Tide Lifts all Boats
What sector has performed the best during the pandemic? Tech Stocks. A sector that appeared to be approaching being overvalued going into the pandemic has shown why it’s constituents are worth every penny. While most other sectors of our economy had to hit the pause button, tech stocks benefitted from everyone being forced out of their offices to work (and play) remotely. When we reference the markets in general, typically we are referring to the indices (S&P, NASDAQ, and the Dow Jones are the more recognizable) to serve as a proxy. Due to the way stocks are represented in the various indices, the large technology companies have a disproportionate effect on the indices as a whole. The boost in the indices from the tech stocks gives the appearance that the markets are being pumped up in general, “a rising tide lifts all boats.”
Rise in Passive Investing
Passive investing has seen a significant rise over the last decade and even more-so over the past couple of years with the emergence of robo- and micro-investing platforms. The gist of passive investing is a desire to realize, but not necessarily exceed, the performance of the overall market. This is accomplished by not actively picking stocks but by investing in securities designed to mimic the movements of the market in general. This “blind” investing style has led to more people being less concerned with the day-to-day nuances of investing, the fundamentals of the businesses, and the general sense of the economy in general. This passive approach led to many investors not necessarily trying to pick which stocks would return to glory in March as we began to make the slow climb back up. To many investors it was more sensible and easier to buy shares of their favorite index (fund) rather than pick and choose the companies to invest in individually. This pulled all of the constituents of the index back up together which has helped propelled us to where we are today.
Markets are known to climb a wall of worry and there are plenty of worries left out there. Many market participants also have a major case of FOMO which also drives market’s higher, especially once we hit new high-water marks like we are today. The markets have looked ahead and priced in a lot of expected positive sentiment. While we aren’t calling for another downturn anytime soon, if today’s forward-looking expectations do not become tomorrow’s reality, we could be looking for markets to reconcile their expectations. All-time high’s often lead to more all-time highs but they also lead to increased risk, which is all the more reason we encourage you to continue working with your advisor on how to keep your portfolio positioned correctly, regardless of what the future has in store.
Ryan Flanders, CFA