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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Struggling to find something new about Wall Street's record-breaking rise ? Some factors we know all about, and some we ought to consider ...... ref :- "The finger points at scarcity as driver of thundering bull run" , The Financial Times 15/11/17 , INSIGHT by Robin Wigglesworth, Markets and Investing

November 16, 2017

 

An article from yesterday, but well worth going back to if you missed it ..... 

 

The reasons behind the spectacular bull run are manifold and occasionally complex ...... unless you're Donald Trump that is, in which case there's a much simpler answer :  HE himself is the driving factor behind it all. We can marvel at the president's levels of self-regard which compels him to seek praise without any apparent embarrassment even when it's not entirely appropriate, but undeniably his stated policy aims are business- and equity-friendly. Of course, the Trump administration is having a very hard time trying to get anything done (what happened to infrastructure spending ?), so we can assume that the markets are taking quite a lot on trust.

 

Actually, they haven't needed to ..... if the president will forgive us, there are other factors that have played arguably bigger roles in the spectacular rise in share prices and they have little or nothing to do with Mr Trump :

 

    Corporate America has been on a supercharged roll for a decade  --  that is to say, for a very long time before the Trump era. Profits have stayed above 10% of GDP throughout the post-crisis era.

 

    If you don't put your money into equities, where are you going to put it ? The average interest rate across G4 countries is still 1.5% below inflation, which is keeping bond yields at or near historic lows. Approximately $11 trillion global bonds still trade with negative yields.

 

Bonds with such low yields, or to put it another way "potential investments that offer such poor returns", are bound to send investors looking for alternatives ...... which for the mainstream investor is of course equities. Andrew Sheets of Morgan Stanley is quoted as arguing : "With rates low and central banks taking great care to avoid (nasty) surprises, the question isn't "why are many assets expensive"...... it's "why aren't they (even) richer" ."

 

Mmm ..... that's a bold call but we take his point. But whether you are beginning to get a little nervous with share prices at these giddy heights or not, there are other reasons behind the markets rise that need to be taken into account. Mr Wigglesworth points us to two in particular : corporate share buybacks, and passive investing.

 

Imagine the total size of the demand for US equities since the financial crisis from institutions, investors , day-trade speculators ..... you name it. Remarkably, that number is less than the number bought through corporate buybacks. If the rate of buybacks is slightly off the high, that's because of the delay in tax reform. Presumably, if and when a deal is agreed over the repatriation of overseas corporate profits and slashing the rate of corporation tax, companies would have more ammunition than ever. But even so, Goldman Sachs estimate that there will be $570 bn in share buybacks this year, and $590 bn next year.

 

If so, that would mean that since the financial crisis US companies have bought back almost $5 trillion of their own shares ..... and that also means that without share buybacks, NET demand for US equities would have been some way into the negative. 

 

That's quite a thought in itself ..... and there's another element to the whole share buyback phenomenon. It goes without saying that the huge equity purchases inherent in share buyback operations are immediately supportive of share prices, but corporate buybacks mean that these shares will not be going back onto the market again . In effect, they have been taken out of circulation ..... and as we know, just like with anything else, scarcity increases value. S & P Global estimate that the number of S&P 500  shares in accessible circulation add up to a value of roughly $306 trillion ..... that's about the same as 10 years ago, despite the market almost doubling in value.

 

So what's this about Passive Investing ? More than $900 bn has transferred from traditional equity funds into passive exchange traded funds (ETFs) over the last decade. So what ? Isn't that just swapping one investment vehicle for another ? And if that's the case, surely the net effect is zero ?

 

In reality, it doesn't work quite like that. You can make an analogy with the Treasury Bond market when the Fed's QE process saw it hoover up huge quantities of bonds. With other demand still healthy, the comparative scarcity of bonds for investors to buy saw prices soar and yields plunge ..... which of course was the whole point of QE in the first place.

 

Wells Fargo argue that something similar is happening with ETF's and their purchases of US equities. With escalating inflows into ETFs (and a rising market), they have almost always been on the buy-side. Since they're hanging on to the shares they've bought, they're effectively taking the shares out of circulation, or reducing the "free-float". As Christopher Harvey of Wells Fargo puts it , passive equity funds have "morphed into a kind of black hole. Money goes in, and stocks never come out". Lots of buyers and fewer natural sellers can only mean one thing for prices .....

 

That's just fine .... until things turn, of course. Then there will be a danger of passive ETFs all trying to unload positions at the same time, which could get bloody. It hasn't happened yet, indeed anyone who's sold stock in recent times has probably had cause to regret it. The argument goes that there's still mileage left in this rally, probably until some way into 2018. 

 

Maybe so ..... and if it pans out that way all these reasons will play a part in it. Mind you, if you're the type to get a bit queasy at high altitude ..... well, we do understand.

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