It’s back to school time for most but back to business for equity markets as they continue their historic bull run of the last 18 months. The German DAX has joined the US markets in breaking to all-time highs and the CAC40 isn’t far behind. Despite some regulatory issues weighing on Chinese Equities by and large, the investment backdrop for equity markets is exceptionally favourable. Record profitability, unprecedented growth opportunities and ongoing strong policy support directed at certain sectors are combining to generate strong investment returns for investors globally.
Corporates are in an even healthier position coming out of the pandemic then they were going into it. Earnings have recovered to above and beyond their pre- crisis levels in a speed that is incomparable to any other recovery in history. Record profit margins have driven upgrades to analysts’ forecasts that have exceeded the year-to-date rally in equity markets. That, rather counter intuitively, leaves equity markets on a lower valuation multiple then when they started the year despite a near 20% surge. Whether one believes this can continue is always up for debate but at the very least it proves the exceptionally strong fundamentals that this market rally has been based on thus far.
This strong earnings backdrop has two other profound consequences which in turn add further support to the rally. Share buybacks this year in the US, which are a function of earnings strength will reach close to $900 billion dollars and may end up being a record year. Corporate M&A in the US year to date, which is a function of strong balance sheets and management confidence will result in over $250 billion needing to be re-invested back in the market by the end of the year as listed companies use the cash on their balance sheet to take out other listed companies. The result of these two factors is a combined demand of well over $1 trillion for the US equity market from the actual market itself.
Policy support, both fiscal and monetary continues to be and will continue to be very supportive for equity markets. Although the level of fiscal support from governments going forward won’t be as large as it was at the height of the pandemic in 2020 it will still be at a level far and above what had become the norm of “fiscal austerity” post the GFC. Of even more importance however is the targeted nature of the spending, focusing on industries and technologies of the future of which the stock market is overrepresented in compared to the economy. Spending of 1-2% of GDP may seem small in the context of the economy overall but for a business when that spending is focused on your end markets it has a materially positive impact.
Similarly, monetary policy wont quite be as supportive as it was in 2020 but compared to any other time in history it is still an exceptional backdrop for investors. The Federal Reserve will begin to taper some of the liquidity they inject into the system by the end of this year but a combination of the need to reinvest maturing bonds and ongoing policies from other global central banks means that the overall global support from central banks, as evidenced by the size of their balance sheets, will still continue to grow in 2022. As no central bank will increase rates while their balance sheets are growing interest rates will remain zero (or below) at least into early 2023. Even then the gradual rise off zero will take years. The only major central bank that had been tightening the Chinese PBOC, is now reversing course and has already begun to cut various benchmark rates. This will add a boost to global growth in 2022.
The nuances around various policy supports can be confusing as political rhetoric smashes into financial jargon. It is critical however not to lose sight of the fact that it is very rare in history to have both monetary and fiscal policy so supportive at the same time. This supportive backdrop is fuelling the exciting secular trends that are changing our lives every day, trends that the largest sectors of the stock market are not only exposed to but central to. Digitalisation, decarbonisation, industrial automation to name but a few. Pfizer, Moderna, BioNTech… all names that roll off the tongue now after their incredible vaccine break throughs and all listed companies. Many of these secular trends are still in their infancy. On a recent conference call highlighted their belief that the current 5% of global GDP that is currently spent on IT will double over the next decade, with 80% of that workload being done on the cloud (versus 20% now).
Although the fundamental backdrop to markets remains strong there are some bizarre occurrences which we are alive to and wary of. The price appreciation of Dogecoin, Meme stocks, Robinhood, NFT’s and Chinese EV’s are all difficult to understand. Luckily however these more esoteric and frothy parts of the market are too small for now to de stabilise the overall markets (although not too small to seriously damage individual investors caught on the wrong side). Recent examples of these mini bubbles or fads coming and going include Tilray, the cannabis stock that in 2018 went from $10 to $300 and back down again or Beyond Meat, the fake meat stock that went from $40 to $250 and back down again in 2019.
A historically strong start to the year can unnerve investors. History tells us that strength such as we have seen year to date tends to continue into year end. The backdrop is there for it to continue into 2022 and beyond.
Philip Byrne is Deputy Chief Investment Officer, Head of Equity Investments at Merrion Investment Managers, a division of Cantor Fitzgerald Ireland.
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