A Running List of Reasons Why Markets Will Go Up No Matter What
by Tiger Gao
Princeton ‘21
These days the vibes in my gym have been very jolly because “STONKS are up HUGE” and all the guys are happily staring at their Robinhood accounts instead of getting ripped like me. S&P 500 jumped more than 7% last week – best week since April – amidst elections uncertainty, record case counts, and round 2 lockdowns in Europe. What is going on?! Torsten Slok, Chief Economist of private equity fund Apollo Global Management, did a webinar at Princeton recently. I asked Dr. Slok this question during the Q&A session, and here are some of his reasons and my thinking. You may watch the recording of Torsten’s webinar on our YouTube channel here. The first three points are made by him, and the following by me:
Investors gained clarity. Normally when a period goes into election, there’s a lot of uncertainty. With more clarity, VIX (the volatility index) will come down, and prices will go up. Sure, the election will only just be officially called today and Trump will still try to pull tricks out of his hat, but starting on Wednesday people adjusted their expectations and realized that we will likely have Biden as the president-elect.
Systemic trends. For a very long time, quant models and risk-parity frameworks have become a more pronounced way of investing, which could help push up the equities when the rates have been consistently going down. Lower rates also lead to high tech stocks since they benefit from that in the long term. So, you can say that the push for higher equities is not solely because of the election outcome per se, and it’s not so much a vote on the election outcome, but it’s because of systematic and quant-driven funds investing.
Financial assets are inflated. You might wonder why we’re not seeing inflation even though the Fed has been printing money non-stop since 2008. That is because they’re all going into credit markets. In monetary theory language – it only creates inflation in financial assets but not transactions in real GDP. Aggregate demand by the broader economy has not gone up. The Fed’s programs can only lift up asset prices but not consumer prices. So, this is another reason why financial assets are inflated and equities are up.
No more Biden’s “harmful” policies. What about the Biden-McConnell gridlock, which will possibly result in little progress? Well, stock markets tend to do well during gridlocks. One explanation is that investors now don’t think we will have a full Blue Wave, so Biden will not get to enact his “harmful” policies on the markets anymore, so the markets can continue to thrive under a de facto Trump policy regime even with Biden as the president. Not saying that this reason is good or bad, but this is a narrative out there.
Broad-based recovery of cyclical assets. Goldman Sachs released their 2021 equities forecast a short while ago. Their very bullish estimates put S&P 500 at 23% return and even STOXX Europe 600 at 21%. One reason they gave is that they "do not think markets have yet priced a robust cyclical recovery.” The S&P 500 is up this year primarily because it’s led by the five mega-cap “FAAMG” firms that have been up roughly 40%. Facebook, Apple, Amazon, Microsoft and Google together account for about 1/5 of the index market capitalization. The larger the firm, the more weight in the index, and the more it carries the index up. So, it skews the picture – the rest of the market is still down this year, and S&P 500 is probably not the most representative index of what the vaccines-led recovery will do to the markets. Cyclical assets are those that do well and badly in line with the larger trend of the economy, so they do well when the economy at large does well. These assets are like restaurants, hotels, airlines, retailers, manufacturers, etc. – not the Big Tech companies. These conventional cyclical assets have largely underperformed in the past few months while the markets have been led by FAAMG. Goldman therefore seems to be saying – if the economy does better, these cyclicals will also do better, and the markets won’t just be carried by FAAMG anymore. Sure, the markets have been HUGE, but they’ll be up even HUGER because of the broad-based recovery.
Recovery not yet priced in. The logic above all makes sense (markets will do better when the economy fully recovers), but the more important claim by Goldman Sachs and the market participants at large seems to be that they don’t think the stock market is really overpriced and all this optimism has not already been priced in. That is something I’m slightly skeptical about. Recall that if you were talking to an investor early this year even three months before Covid-19 happened, many of them would be complaining how the stock markets should have a 20-30% healthy correction because the valuation is too high for everything. And at the beginning of the Covid-19 crisis, an endless stream of articles were written about the disconnect between economic reality and financial boom. This does not seem to be the case anymore, and investors have become much more comfortable with this ever prosperous trend we’re headed towards.
Focus on macro factors and shift away from business fundamentals. I acknowledge there are certainly factors beyond just business fundamentals that are carrying the markets up: like the Fed’s low interest rate for the foreseeable future and apparent inability to exit out of the current money-printing spree, combined with very low inflation expectation (outlook is around 0.5-0.75% which is significantly below 2%). But are these factors that important such that they're enough to overshadow the horrible underlying economy? So here seems to be the ultimate logic: these pro-markets macro factors weren't present before Covid, so people only focused on the business fundamentals, and clearly back then sensible investors recognized that the markets were overvalued. But now, business fundamentals have become even worse, but fortunately we got all these additional macro factors like Fed pumping money to justify a bull market, so we should actually just care much less about the business fundamentals right now. In fact, forget that we ever worried about the markets being overvalued. That's a stupid thought.
It's just amusing – 4 months ago people are still freaking out about how the markets seemed disconnected from the Covid depression & Main Street suffering reality, and today the narrative is that we're in the beginning of a very young bull market (even though the markets have been going up pretty much nonstop since March in a global recession and is arguably even more overvalued than ever)...
I will continue to list out more reasons as the situation evolves. The bottom line is: there are always factors we can look for to get the markets up…