Last week, the Nasdaq 100 hit a new all-time high. The rise is aided by strong gains in tech stocks like Apple, Amazon, and Netflix. The S&P 500 is down only 1.1% for the year. Many experts have said US stock markets are out of sync with fundamentals. From Paul Tudor Jones to Jeffrey Gundlach, almost every known fund manager said that US stock markets are bound to crash to their March lows.
However, let alone a stock market crash, we’re now talking of new all-time highs. Looking at the momentum, the S&P 500 might also soon hit all-time highs. Such consensus macro views have been squarely wrong since 2018. Read The Perils of Consensus Investing: Key Takeaways for more insights. But then, stock markets rising to record highs despite no end to economic woes of the coronavirus seems to defy the traditional thinking.
Now, stock markets are forward looking by nature. Economic activity is expected to resume to normalized levels once the pandemic is controlled. The progress over the vaccine has also been encouraging. That said, there could be changes in consumer behavior once the pandemic is over. This is among the risks that markets are ignoring as I noted in a previous article.
As for the vaccine, we still do not have a ready vaccine. While we should have it in due course, for now, the pandemic has left a deep crater in global as well as the US economy.
The Fed’s unprecedented easing coupled with trillions of dollars of federal stimulus has catapulted US stock markets higher. Now, from a traditionalist view, equity investments are risky and investors seek a return that includes the risk-free return plus the risk premium. The required rate of return is inversely proportional to stock prices. The lower the required rate of return, the higher the stock prices.
Now, the Fed’s easing has brought the risk-free rate back to zero bound. But then, what about the risk premium? It’s a bit tricky. While macro risks have only risen amid the pandemic, we have the Fed and Federal government backstop.
According to Warren Buffett, “Risk comes from not knowing what you are doing.” In current markets, when you know that the Fed and Federal government would bail out companies and by extension the markets, there is little risk in investing in stocks. While the risk of short-term volatility remains, the government support at least addresses the tail risk of a sharp crash.
Now, we can talk about all the moral hazards with some people earning more now due to federal stimulus and the bailout helping companies that did not build a sustainable balance sheet and were instead buying back shares even using debt. That can be a discussion for another day.
Meanwhile, a fallout of the near demise of traditional investing is that value investment strategy has underperformed growth strategy. Berkshire Hathaway has now underperformed for a decade. Read Is Value Investing Dead as Many Proclaim? for more insights.
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