The strong backdrop for equities will be there until next year
Back to school for the most part, but back to business for the stock markets as they continue their historic 18-month bull run. The German DAX has joined the US markets by hitting all-time highs and the CAC40 is not far behind. Despite some regulatory issues weighing on Chinese equities overall, the investment environment for equity markets is exceptionally favorable. Record profitability, unprecedented growth opportunities and continued strong political support for certain industries combine to generate strong returns on investment for investors around the world.
Businesses are in an even healthier position coming out of the pandemic than they were entering. Profits recovered beyond their pre-crisis levels at a speed unmatched by any other recovery in history. Record profit margins have led to upward revisions to analysts’ forecasts that have outpaced the rally in stock markets since the start of the year. This, rather counterintuitive, leaves the stock markets at a valuation multiple lower than at the start of the year, despite rising nearly 20%. Whether we think this can continue is still up for debate, but at the very least, it proves the exceptionally strong fundamentals that this market rally has been based on so far.
This solid earnings backdrop has two other profound consequences which, in turn, add further support to the recovery. Share buybacks this year in the United States, which are a function of strong earnings, will reach nearly $ 900 billion (€ 760 billion) and could be a record year. The mergers and acquisitions of companies in the United States since the start of the year, which are based on strong balance sheets and management confidence, will result in the reinvestment of more than $ 250 billion in the market by the end of the year. end of the year, as listed companies use cash on their balance sheets to exit other listed companies. The result of these two factors is a combined demand of over $ 1 billion for the US stock market from the market itself.
Political support, both fiscal and monetary, continues to be and will continue to be very favorable to the stock markets. While the level of government budget support going forward will not be as high as it was at the height of the pandemic in 2020, it will still be at a much higher level than what had become the norm for Post-financial “fiscal austerity”. crisis. The targeted nature of spending is even more important, focusing on industries and technologies of the future that are overrepresented in the stock market relative to the economy. Expenditures of 1 to 2 pc of GDP may seem low in the context of the economy in general, but for a business, when these expenditures are focused on your end markets, they have a noticeably positive impact.
Likewise, monetary policy will not be as favorable as it was in 2020, but compared to any other time in history, it still provides an exceptional backdrop for investors. The Federal Reserve will begin to cut some of the liquidity it injects into the system by the end of this year, but a combination of the need to reinvest maturing bonds and the ongoing policies of other global central banks means that the aggregate global support of central banks, as evidenced by the size of their balance sheets, will continue to grow in 2022. Since no central bank will raise rates while their balance sheets increase, interest rates will remain zero (or lower) ) at least until early 2023. Even then the gradual rise from zero will take years. The only major central bank that had tightened, China’s PBOC, is now backing down and has already started cutting various benchmark rates. This will give a boost to global growth in 2022.
The nuances around the various political backers can be confusing as political rhetoric weaves its way into financial jargon. However, it is essential to remember that it is very rare in history to have both such favorable monetary and fiscal policies. This backdrop fuels the exciting secular trends that are changing our lives every day. – trends to which the largest sectors of the stock market are not only exposed, but of which they are also a central part.
Digitization, decarbonization, industrial automation are just a few examples. Pfizer, Moderna, Biontech are all names coming out of the tongue now after their incredible vaccine breakthroughs and they’re all listed companies. Many of these secular trends are still in their infancy. In a recent conference call, Microsoft highlighted its belief that the 5% of global GDP currently spent on IT would double over the next decade, with 80% of that workload done in the cloud (up from 20% currently).
While the fundamental backdrop for the markets remains strong, there are some strange events that we are aware of and wary of. The appreciation in the price of dogecoin, meme stocks, Robinhood, non-fungible tokens and Chinese electric vehicle makers are all difficult to understand. Fortunately, however, these more esoteric and foamy parts of the market are too small right now to destabilize the entire market (although they are not too small to seriously harm individual investors caught on the wrong side). Recent examples of these mini-bubbles or fads that come and go include Tilray, the cannabis stock that in 2018 went from $ 10 to $ 300 and back down, or Beyond Meat, the fake meat stock that went down from $ 40. to $ 250 and goes down again in 2019.
A historically strong start to the year can upset investors. History tells us that strength as we have seen it from the start of the year tends to continue until the end of the year. The backdrop is there for this to continue into 2022 and beyond.
Philip Byrne is Chief Investment Officer of Merrion Investment Managers at Cantor Fitzgerald Ireland