Well, stock markets have started off with a bang in 2018, with some very quick market gains right out of the gate. Market doomsayers again look bad, at least for now.
Every single stock trade, of course, is an equal and opposite prediction of what might happen. But the bulls are certainly winning the current battle. What’s going on? Why all of the excitement? Well, there are multiple reasons. However, there could also be a case made to be very cautious. For now, though, like a good DJ at a party that has lasted into the wee hours and who is trying to keep the party going, let’s spin some reasons why the market rally might indeed continue for some time:
Everyone is “looking” for a correction
At 5i Research, many of our customers are asking about ‘going to cash’ or asking about products that can hedge their portfolio. Investment advisors are exercising caution with clients’ portfolios. Famous investors are warning about market exuberance. But, just like how it never rains when you take an umbrella out, a market correction rarely happens when everyone is looking for one. Investors’ concerns get priced into the market, so ‘bad’ news is ignored and ‘good’ news is rewarded, as investors are too pessimistic. This may be occurring now.
Everyone seems worried about the lack of volatility in the market, with very few big market swings and the VIX volatility index hovering near record lows. But, maybe volatility levels are low because conditions are just ‘good’. Low volatility means stocks should be valued higher as equity risk goes down. That stock you sold at $50 which is now $70? The low volatility might explain why investors are willing to pay more for it today than five months ago.
Interest rates are going up
No one disputes that. The Bank of Canada raised rates this week. So, if rates go up, bonds are usually less attractive as investments, with prices moving inversely to rates. At the same time, corporate earnings are rising and U.S. corporate tax rates are falling. So, we have an asset sector with negative influences (bonds) and an asset sector with positive influences (stocks). This might be resulting in a generational shift from bonds to stocks, and could be one reason why the stock market party continues. Bonds went on a 30-year run, maybe stocks are currently in a very longer-term bull market than many investors realize.
Corporate earnings are really, really good
As mentioned above, there are a lot of positives occurring in the corporate world. Taxes are down, margins are up, revenue is improving, acquisitions are occurring and dividends are being increased. Business is, in a word, good. Since the market is driven by corporate earnings, it is not surprising the market is reacting well to what’s going on in the business world.
Global synchronized growth
For the first time in a very long time, most major economies of the world are all in growth mode at the same time. Europe is recovering, Asia is doing well, and the U.S. economy is on fire. Since markets rallied so hard when it was just the U.S. economy that was strong, maybe markets are due for even bigger gains as the rest of the world’s economies pick up momentum.
Back to our DJ reference
Keep in mind that, like a DJ spinning a tune he doesn’t even like, just to keep the party going, we are not saying for that markets will certainly keep rising. At some point, there is going to be a correction. But the next time you are selling only ‘because markets have gone up too much’, keep these five points in mind.
Peter Hodson, CFA, is Founder and Head of Research of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (http://www.5iresearch.ca).