Market enthusiasm lacking in fundamentals
In era of interventionist policies and easy money, investors get complacent
Like hippie love-ins and disco, fads are often remembered with fondness by those who lived through them. This drives younger people completely bonkers, of course, but we do it anyway. And it’s little different with investing.
If we’re honest with ourselves, those of us old enough to remember the boom of the late 1990s will not be able to really deny that we were caught up in a contagious spirit of optimism and change. Yes, it all ended badly — terribly, in fact. But before the collapse of the dot-com bubble in 2000, investors largely drank the Kool-Aid, and we liked it.
Admit it: We believed the Internet would change everything, that the demand for bandwidth would double every week or so, and that telepresence really was around the corner.
We bought tech and telecom stocks; some of us even thought about how we could get venture capitalists interested in our idea for the next Pets.com. And it didn’t hurt our enthusiasm that a lot of us (well, not me, but you know what I mean) managed to make a lot of money as markets reached all-time highs. For a while, at least. Veteran market-watchers downplay the importance of stock market milestones, but stock markets are once again achieving record highs. If we’re wondering how long the good times will last, maybe we should begin by asking why they’re here in the first place.
The Nasdaq hit 5,000 this week for the first time since March 2000. The S&P 500 reached new highs four times last month, and both it and the Dow Jones Industrial Average posted record closes earlier this week.
U.S. markets aren’t alone in this. The FTSE 100 in London recently surpassed the previous high set during the dot-com boom, while Mumbai’s S&P Sensex and Nifty indexes both posted levels never before seen. Even Canada’s S&P/TSX composite, battered by plunging commodity prices, is still less than 500 points off its record high set last September. And in Japan, which has yet to emerge from a deflationary cycle that has lasted more than three decades, the Nikkei 225 index achieved a 15-year high in February.
What’s remarkable about these gains is that they are so widely and evenly distributed. Even within indexes, dispersion of returns remains low. (Canada is a bit of an exception thanks to the free fall in oil prices.) The rising tide is lifting all boats. What’s the story behind this rally? Well, no one can really pretend that stock returns and economic performance have much to do with one another.
Global economic growth is anemic. Yes, the U.S. economy seems to be on a recovery path, but its growth appears robust only by comparison to the depressingly disappointing performance by the rest of the developed world.
As a result, today’s market enthusiasm is far more pedestrian than we old-timers like. It has little to do with fundamentals, or even disruptive technologies. It has a lot to do with monetary policy. This shouldn’t necessarily make anyone feel any better.
Central banks around the world have made two things clear. First, they are prepared to maintain extraordinarily stimulative monetary policies until the data prove their economies are on a firm growth trajectory. Second, they are prepared to do everything in their power to prevent a disaster of the scale seen in 2007/2008.
For investors, the first imperative translates into suppressed bond yields, creating limited options for returns. Low or even negative (in Europe) yields and accommodative monetary policies tend to push investors towards stocks. And more people buying equities means higher-priced equities. Hello, all-time highs.
But the second imperative may be more troubling if the willingness to ensure soft landings leads investors to believe that central banks will always step in to help and that their interventions will always work.
Maybe it will. Maybe this new era of low growth, easy money and interventionist policies will last a long time, deferring strong corrections while producing a golden age for stock markets.
But a smart investor might want to put less faith in central banks and more thought into fundamentals. Now is the time to start thinking about what happens when central banks turn off the taps or if real economies prove unresponsive to monetary stimulus — and not get too addicted to the Kool-Aid.