It’s natural to question rallies in the stock market, but the animosity toward the latest leg up that has pushed the S&P 500 Index, Dow Jones Industrial Average and the Nasdaq Composite Index to new records seems truly exceptional in its cognitive dissonance.
I have spent a 20-year career in finance, so I am used to the stock market confounding naysayers, but this a bit extreme. Equities are on pace to deliver their best annual performance since 2013, with gains this year already exceeding 23% for the S&P 500, and yet investors have poured about $450 billion into money market funds, which is the most since the financial crisis year of 2008. And almost any survey of the mood in markets is far from euphoric levels.
The pessimism is partially because of politics. There are days when it seems as if Democratic Presidential candidate Elizabeth Warren’s proposals (she’s a frontrunner at the moment) are designed to specifically poleax the stock market. President Donald Trump’s tax cuts of 2017 were mostly a corporate tax cut, giving a boost to stocks. Warren’s tax hikes, like corporate taxes and even a wealth tax that would require the liquidation of public equities, would do the opposite.
Nobody is happy about this, and yet stocks go higher. Whatever odds you place on a Warren -- or even a Bernie Sanders -- presidency, it is not zero. And if it’s not zero, then the market discounting mechanism should take over. Yes, the election is about a year away, but the market is capable of looking that far into the future.
There is also ample evidence the economy is slowing independent of the political noise. Pretty much every major manufacturing survey has dipped into recession territory, and jobs growth has slowed. There are the usual worries about leverage, especially in terms of credit card, auto and student loan debt, but those seem to be a permanent feature of markets.
More worryingly, the Federal Reserve has cut interest rates three times since the end of July. Maybe it was in reaction to criticism from Trump that monetary policy is too tight, but the reality is that the Fed has access to more data than the rest of us, and I find it hard to believe it would embark on a rate cutting campaign if there wasn’t real reason to believe that the economy was slowing. And then there is the repo madness, which, depending on who you talk to, is either a big deal or it isn’t.
Actually, the most worrying thing about monetary policy these days is not the rate cuts, but the Fed’s communication. Going from claiming that rates were “nowhere near neutral” to multiple cuts in less than a year does not inspire confidence.
There are always more reasons to sell stocks than to buy them. I personally have a tough time getting excited about stocks at these valuations. But I think people lose sight of one key factor that drives the equities market: supply and demand. The number of publicly traded companies has dropped by about half in 20 years, from about 7,000 to about 3,500. This means there is more money chasing fewer shares. The boom in stock buybacks has likely reduced outstanding shares even more.
Demand is a bit tougher to measure, but we know that a few billion dollars flows into index funds every day, supporting the broad market. This is not necessarily new money, but rather cash coming out of actively managed funds.
I say this with the highest level of self-awareness I can muster: it is very hard for stocks to go down until the supply-demand dynamic changes, either with more initial and secondary public offerings, or there is a sea change in how investors view stocks. Of course, just when investors collectively believe this, is usually when the stock market finally drops. We are not there yet.
Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of 'Street Freak' and 'All the Evil of This World.' He may have a stake in the areas he writes about.
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