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How is the market almost back up to where it was before Covid-19? Part 1

This has to be the most common question I have received over the last few weeks. The answer was getting too detailed so this week is part 1 and I will continue next week with part 2.

Just a reminder, as having worked in financial markets for more than 20 years and on trading floors for over 10 of those, my views are probably slightly different than your everyday financial planner or even economist. Financial markets have certain characteristics and hidden “rules” that don’t make obvious (or economic) sense to people outside of this bizarre little world. I see my role as someone who is trying to drag back the curtain for you and explain what is going on and why. But, please remember these are just my views only. So with that, lets dive in to the first point which is the number 1 rule of investing….

The stock market and the economy are two very different beasts. 
Think about the top 5 largest weightings in the US S&P 500 index – Microsoft, Apple, Amazon, Google and Facebook. Do they sound like companies that are driven by the US economy? Absolutely not. These are global companies that just happen to be based in the US. Just because the economy is struggling in a particular region, doesn’t mean the stock market has to struggle. But, the whole world has been shocked into recession I hear you say? Yes, thats true, but look at these companies – remember the largest 5 weightings in the largest stock market in the world. Think about their business models. I would argue that for almost all of these companies, this lockdown period has actually enhanced their business models and made them even more valuable. When the largest companies in a stock index are doing well, the index finds it hard to fall. Which brings me onto point number 2…

The translation of the above maths is that short-term moves in stock markets are driven by 2 main factors – liquidity and positioning. On a long-term basis, yes valuations and earnings growth and all those traditional measures matter. But on a short-term basis (say 1 year or under) the swings in the market are driven far more by liquidity and positioning. So let’s look at liquidity first… what is that? Very simple. Pure cash.

This slide may be a little hard to read, but what it is meant to show is the massive jump in central bank stimulus that the markets have received over the past 3 months. Reuters estimated this figure to be around $15 trillion (yes trillion) which equates to around 17% of total global economic output of 2019 (estimated $87 trillion). Billion, trillion, its all the same, so what does it mean? Simple answer: The way this money actually gets itself into the economy is the central banks literally print it (or create it), then use it to buy Goverment and other bonds off the banks. So this money then is transferred to the banking system. So now its up to the banks in terms of what they do with it. Do they make more loans? Perhaps yes, but they’ve got Goverment guarantees on those anyway. Do they pay dividends? Unlikely as dividends are politically sensitive at the moment as they are seen as rewarding “rich” shareholders. Make it easier to get mortgages? Perhaps, but we saw what happened with that in 2007. So, frankly, the banks are a bit stuck with this money. So where does it go? Bank into the markets… The banks need a return on these funds just as you & I do, so much of it ends up in all our global stock markets. When liquidity is running and cash is being forced into the market like this, it becomes a simple case of demand being greater than supply which pushes prices up. And in my view, that is what is happening right now. Obviously, when the central banks are removing liquidity the opposite happens and we saw this in the period October to December 2019 when the markets fell sharply. So this can easily reverse, however for now, its pushing everything higher.

That’s the end of part 1. I will return next week with part 2 which looks at more on liquidity, positioning and where we go from here.

##The above is not specific financial advice. Please get in touch for tailored advice on your individual situation. Obviously, prices can move down as well as up.. but you all definitely know that.##