The stock market advance since late March could be termed the Terminator rally. Like Arnold Schwarzenegger’s cyborg assassin, nothing seems able to stop it.
On June 11, global equities dropped almost 5 per cent in the biggest aftershock from the sharp declines of March, as investors were spooked by renewed Covid-19 cases and a gloomy US Federal Reserve. Even so, the FTSE All-World index has since recovered and remains on track to complete its best quarter in more than a decade.
US equities continue to lead the charge. The S&P 500 is up 21 per cent since April, on course for its best quarter in more than 20 years. The worst global economic downturn since the Great Depression, plummeting corporate earnings and rising geopolitical tensions have done little to slow the remorseless moves upwards.
“It’s the equity market that won’t die,” said James Athey, an investment manager at Aberdeen Standard Investments.
The power and pace of the recovery stands in contrast to the murky economic and political backdrop. Add in recent signs that some places are seeing coronavirus infections tick up again after ending lockdowns, and many veteran investors are stumped.
“I have been completely amazed,” Jeremy Grantham, the founder of money manager GMO, told CNBC this week. “The great bubbles can go on a long time and inflict a lot of pain but at least I think we know now that we’re in one. And the chutzpah involved in having a bubble at a time of massive economic and financial uncertainty is substantial.”
Yet some fund managers think the upbeat tone in stocks is here to stay. “There’s room for risk assets to move higher,” said Salman Baig, a portfolio manager at Unigestion, an asset manager.
Persistent strength in haven assets such as bonds and the narrowness of the US stock market rally, which has focused largely on tech, suggest many investors have not jumped in, he said. He added that the performance of trend-following hedge funds and other automated strategies linked to volatility showed a low correlation with movement in stocks, suggesting that many such investors were still on the sidelines. “When they move, they tend to move en masse,” he said. “That could really push up prices further.”
Nonetheless, US equities are looking particularly frothy, with a cyclically-adjusted price-to-earnings ratio of nearly 30, almost twice the long-term average. Almost four in five fund managers surveyed by Bank of America this month think stocks are overvalued, the highest share since the poll began in 1998.
A ferocious response by central banks has been the main driver of the rebound, according to analysts and investors. “The massive stimulus from the Fed affects capital markets more than anything else,” said Kristina Hooper, chief strategist at Invesco. “What we have [as a result] is a decoupling of markets from the economy.”
In the 1990s, investors grew accustomed to the “Greenspan put”, named after the famed Fed chairman of the era whose rate cuts were seen as an effort to support asset prices. Now, with other major central banks pulling in the same direction, investors have “the Greenspan put on steroids”, said Valentijn van Nieuwenhuijzen, chief investment officer at Dutch asset manager NN Investment Partners. As long as that is in the background, any signs of brighter news on the pandemic, such as slowing death rates, create a “sweet spot” to keep pushing markets higher, he added.
Some economic data have come in better than expected, fuelling hopes of a V-shaped recovery that will justify the high prices. This has become particularly noticeable in the US, where Citi’s Economic Surprise index — which measures the strength of data compared with estimates — is at an all-time high.
Sceptics point out that while economic activity was always likely to return quickly once lockdowns ended, the scale of the downturn means it could take years to get back to the levels seen earlier this year.
Moreover, Richard Barwell, head of macro research at BNP Paribas Asset Management, pointed out that better data could in fact be a negative sign. “If activity is stronger than expected, then social distancing is probably collapsing and the chances of a second wave [of infections] increases.”
According to Peter Oppenheimer, chief global equity strategist at Goldman Sachs, there are signs that the new bull market is broadening beyond tech and into more economically-sensitive sectors, indicating that more investors are getting sucked back in. “There’s a real fear of missing out,” he said. “But I would be quite cautious.”
Even optimists say the market will continue to be tumultuous. The big wobble last week “tells you something about the fragility of the rally”, said Mr van Nieuwenhuijzen. “As soon as there’s a second wave or a sense that there’s a re-acceleration in the virus, it’s not hard to imagine that there will be a reset of sentiment.”