Stock markets around the world continue their recovery in what seems to be one of the most annoying rallies in history. Market participants are confused to see asset prices so inflated during an economic downturn, but in reality, there are several important reasons this continues to be the case. Challenges will lie ahead, without a doubt, however, thus far we have to deal with the stock markets as they are, which makes it important to talk about some of the reasons behind this rally.
#1 Central bank stimulus
Financial markets around the world had been flushed with more than $4 trillion of liquidity during the past few months, and given the depressed conditions of the stock markets + resilience from the banking sector to lend due to the economic contraction, a lot of the funds had been pouring into stocks. Exploiting volatility had been a real challenge, but now central banks had managed to reduce market volatility to more manageable levels. What’s even more important is that aggressive money printing will continue in the near term, as long as the economy will suffer.
#2 Economies reopen
After two months of lockdowns, European and North American countries are starting to reopen. COVID-19 infections had eased and despite more than 5 million cases already detected, the spread of the virus had been contained. Now that economies are beginning to start a normalization process, this means people will start spending again and companies will have new revenue. How that revenue will compare to 2019 or 2018 is another important story that will have great importance. In the meantime, market participants are optimistic about the reopening, until the data will point anything else.
#3 Stocks’ relation with bonds
If we look at the US market, the 10Y treasury yield is close to 0.7% per year, while the yield on the S&P500 is approximately 1.9%. Viewed from this angle, bonds are almost three times more expensive than stocks, which is facilitating the current market rally. Setting trading targets when the economy turns south is very difficult since other metrics point out stocks are as expensive as during the 2000’s dot.com bubble.
Which side of the market will be right only time will tell. But in the meantime, stocks should outperform as long as Treasury yields will remain close to record lows. Yields starting to rise won’t be good for stocks. However, aggressive central bank intervention keeps the situation stable for the time being.