Breaking News
Get Actionable Insights with InvestingPro+: Start 7 Day FREE Trial Register here
Investing Pro 0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

Can Anything Stop The Stock Market?

By XM Group (Trading Point )Stock MarketsNov 26, 2021 09:05AM ET
www.investing.com/analysis/can-anything-stop-the-stock-market-200609643
Can Anything Stop The Stock Market?
By XM Group (Trading Point )   |  Nov 26, 2021 09:05AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
Stock markets have gone on an absolute rampage this year. The problem is that the factors that initially fueled this rally - heavy government spending and endless central bank liquidity - are slowly fading away. Meanwhile, new covid variants are threatening growth. Can corporate buybacks, the weaponization of call options, and sheer momentum keep this party going?

Rocket fuel

There’s a clear sense of euphoria driving this bull market. Asset prices seem almost immune to bad news, every dip is a new opportunity to buy, and momentum is king. Take covid news. Fears of a new vaccine-resistant variant dragged US markets lower today, but the losses were not dramatic.



Of course, this has been the story for almost two years now. When extravagant government spending meets negative real interest rates from central banks, that is rocket fuel for markets. Interest rates are essentially the price of money. If that price is negative once you account for inflation, then everything else automatically becomes attractive.

There’s also the powerful force of corporate buybacks, which are on track to hit new records this year, and the explosion in options trading. Since options have embedded leverage, betting that a stock will rally this way allows traders to ‘pack more punch’ in pushing the shares higher.



But when equity markets rally by almost 30% in a single year, it’s time to pause and reflect. Are these elements still in play or have investors taken their eye off the ball?

Fading support

Admittedly, the road forward seems much more challenging. The fastest pace of the economic recovery is probably behind us, while central banks and governments are both stepping back from the tremendous support they have provided so far.

The surge in inflation has been a game changer for central banks. The long-standing assumption that the ‘Fed has our backs’ in the sense that any market decline would result in policy action that helps stocks bounce back, may not hold anymore. With US inflation running above 6%, the central bank doesn’t have much room for helping markets if a correction strikes.


On the fiscal front, there isn’t much political appetite anymore for huge stimulus packages. Most economies have stabilized and government debts have ballooned. Instead, corporate taxes are moving higher. The G20 nations have brokered a deal that would set a global minimum tax rate of 15% on large corporations, which is expected to come into force in 2023.

Another issue is the growth trends in China and Europe. Chinese economic growth is likely to slow down as the property sector deleverages, which is also bad news for Europe that relies on China to absorb many of its exports. The euro area faces the risk of new lockdowns too as infections are soaring again, and that’s even before the ‘Nu’ variant appeared.

Valuations aren’t cheap

Most valuation metrics have corrected from their peaks earlier in the year, but remain in ‘danger zone’ territory. The 12-month forward price to earnings ratio for the S&P 500 stands at 21.5x, which is extremely elevated by historical standards.


The forward price-to-sales ratio is also inflated at 2.8x, while the famous Buffett indicator which measures the entire stock market capitalization relative to the US economy is far higher than any previous bubble. This indicator may not be so relevant anymore as US companies sell more abroad than in the past, but it still suggests the market is pretty expensive.

Here’s the problem - it’s one thing for the market to be overpriced when both fiscal and monetary policy are extremely loose. That’s natural. But when these forces are both fading and valuations remain this stretched, it’s a much bigger concern.

What’s next

Equity markets have displayed an incredible ability to absorb bad news without much damage. We probably have the storm of corporate buybacks and the depressed levels of real yields to thank for that.

But if real yields dare to rise from record lows, that could spark a reality check. We have already gotten a taste of that recently. While the major indices on Wall Street remain near record highs, there’s been a quiet massacre under the hood in cash-burning companies, mostly in the tech sector. Those are the most sensitive to rising yields.


The real question is, what could propel real yields higher? The answer may be ‘peak inflation’. With inflation roaring higher lately, investors are buying inflation-protected bonds in truckloads. This demand is keeping ‘real’ yields pinned on the floor. But once we see the first signs that inflation has actually peaked, this dynamic could change.

Ultimately, there’s nothing else

Now to be clear, all this argues for a correction, not a crash. Markets simply seem to have run too far ahead of fundamentals, projecting forward the favorable conditions that have dominated so far. But things are changing, especially on the policy front.

In the longer run, stock markets tend to follow the economy, which is healing quickly. Cheap money from central banks certainly helps a lot, but as the 2015-2019 experience showed, equities can flourish even with rising rates and fading liquidity.

After all, what else is there? Central banks have killed bonds as an asset class, while commodity and crypto markets are too small and volatile for ‘big money’. A correction may be overdue, but ultimately there’s just no alternative to stocks.

Can Anything Stop The Stock Market?
 

Related Articles

Michael Kramer
NASDAQ Could Fall Another 13% By Michael Kramer - Jan 28, 2022 5

This article was written exclusively for Investing.comThe NASDAQ Composite has fallen sharply to start 2022, down nearly 13%. But don't expect the index to race back to record...

Can Anything Stop The Stock Market?

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.
Continue with Google
or
Sign up with Email