This Stock Market Rally Might Be Far From Over

This Stock Market Rally Might Be Far From Over
Andrew Rummer

over 2 years ago4 mins

  • Even though global stocks are up nearly 90% from last year’s lows, there are still plenty of reasons stocks should continue to provide investors with returns.

  • From rebounding earnings expectations to cooling inflation worries, stocks could be entering a goldilocks period.

  • The easing of speculative fervour and excessive bullishness from some investors only adds to my conviction that the darkest fears of commentators may never come to pass.

Even though global stocks are up nearly 90% from last year’s lows, there are still plenty of reasons stocks should continue to provide investors with returns.

From rebounding earnings expectations to cooling inflation worries, stocks could be entering a goldilocks period.

The easing of speculative fervour and excessive bullishness from some investors only adds to my conviction that the darkest fears of commentators may never come to pass.

Mentioned in story

The dust has settled after last year’s ugly coronavirus-inspired crash, and global stocks have risen nearly 90% from last year’s lows. But with this comes the naysayers who see a bubble that’s destined to burst before long. I’m not one of them: I think there are six compelling reasons you’ll want to keep stocks at the heart of your portfolio.   

1. Analysts have been proven overly pessimistic

Analysts have mostly been negative about the speed of the bounce-back in company profits all through the pandemic, and they’ve consistently been forced to hike their estimates after companies performed much better than they expected. 

In the first quarter of 2021, for example, analysts originally thought earnings at companies in the key US stock index – the S&P 500 – would grow by 16%. By the end of reporting season, profit growth turned out to be 58%

2. Stocks aren’t that expensive

The MSCI All-Country World Index – a benchmark gauge of stocks in both developed and emerging markets – is currently trading for 19.5x this year’s estimated profits. That so-called price-to-earnings (P/E) ratio is down from a peak of 24.3x in December, and compares to an average of 15.6x over the past two decades. 

And as company earnings climb, the “E” part of the P/E equation is increasing, and valuations are dropping from their historic highs. 

Chart of stock market valuations

3. Central bank support isn’t going anywhere just yet

A large part of the recent inflation pickup we’ve seen – at least in the US – has been caused by  supply-chain disruption following the pandemic. But as businesses get back to normal, we’re seeing spikes in the prices of raw materials like lumber fall back, easing inflation pressures. That should wind down the pressure on central banks – chief among them the US Federal Reserve (Fed) – to reduce their support for markets and the economy. 

There’s a market cliché that goes “Don’t fight the Fed”. And as long as the “true” US unemployment rate – including part-time workers – stands at more than 10%, it’s hard to see the US central bank taking any steps to increase borrowing costs. Indeed, Fed policymakers aren’t expecting to raise interest rates from their current near-zero levels until 2023 at the earliest. 

Chart of lumber prices
Lumber futures have fallen back since May

4. …which is making stocks look cheaper than bonds

The bond market is already reacting as investors moderate their inflation worries: they’ve been more willing to buy US government bonds (a.k.a. Treasuries) in recent weeks, a move which is driving down yields. 

Those declining yields on government bonds – considered a risk-free place to put your money – are making stocks look more attractive. The so-called “earnings yield” for the MSCI All-Country World Index – which rises as stocks get cheaper relative to profits – has been steadily climbing since March compared to this risk-free bond yield. The spread rose to 2.2 percentage points this week, not far off the average of 2.5 points over the past two decades. 

Chart of stock valuations compared to bonds

5. Markets are a lot less speculative than they were

When P/E ratios were peaking in late 2020 and early 2021, plenty of commentators pointed to speculative excess as a sign of an imminent market crash. Jeremy Grantham of Boston-based investment firm GMO, for one, told us in January that the surge of money flowing into unprofitable companies like battery maker QuantumScape, special purpose acquisition companies (SPACs), and bitcoin were all flashing red lights. 

Still, the Defiance Next Gen SPAC Derived exchange-traded fund – a benchmark for SPAC stock prices – has dropped some 25% from its February high, while bitcoin has nearly halved from its peak in April. Combined with a collapse in Google searches for terms like “buy stocks”, it seems the froth may have blown off the most speculative parts of financial markets – without inspiring wider panic. 

Chart of Google searches for “buy stocks”
Google searches for “buy stocks”

6. Bull markets are supposed to end in euphoria

To cap it off, investor sentiment is far from excessively optimistic at the moment. The American Association of Individual Investors’ (AAII) bull-bear indicator is sitting at just 17. That’s well off the highs that often precede market pullbacks, and not much higher than the average reading of 5.9 we’ve seen over the past 20 years. 

Chart of AAII bullishness

So stocks are admittedly unlikely to give blockbuster returns at current valuations, and it'd certainly be hard to argue that the market is anything approaching a bargain. But they still have plenty of charms as a home for your investments, and there’s no reason you shouldn’t keep them safe and sound as part of your longer-term investment portfolio.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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