The Case for Why Stocks Should Continue to Rally

Stock markets have bounced back well from their coronavirus caused fall back in February and March but now investors are questioning why the indexes should be so high when we have the worst economic conditions for over 80 years.

There are many good reasons why stocks should be high.

  1. The coronavirus impact is not negative for all companies. Some benefit and some lose

The stock market is made up of many different segments and industries have been impacted differently by coronavirus and lockdown measures. Yes, we might see credit issues filter through as bad debts to the banks so it makes sense that Commonwealth Bank share price should fall. At the same time, everyone is now buying things online so it makes sense that the share price of Amazon should rally.

Never fall into the trap of thinking all stocks are the same. No matter what is going on in the world there are some companies benefiting. Your job is to find out which ones.

So, when someone asks why is the stock market so high? You should respond “which market and what is considered high?”

  • Government Stimulus

Governments around the world are printing money and injecting it into the system to stimulate their economies. Printing money means there is more money in the system. More money in the system means the value of each parcel of that money becomes less. Therefore, you need more of those parcels to buy something like a share in Apple. We call this inflation.

Apart from some companies making more profits because the environment suits them, inflation is driving the price of shares in companies higher in general.

You can see this inflation in the AUD.USD exchange rate which is closing in on 0.72 and is at levels not seen since early 2019. The Aussie is gaining ground because we are not printing as much as the US to keep our economy afloat.

You can also see it in the price of Gold. I get annoyed at commentators saying gold is going higher because investors view it as safe haven in times of uncertainty. This is simply not true. Go and look at when gold moved higher and you will find that gold only ever moves up due to expectations of inflation…..which is of course why it is heading higher now.

The only real hedge against inflation is an asset that grows with inflation. Such as shares of a profitable company. A well-run company should improve profits during times of inflation which in turn should cause the share price to rise.

On this point, we would also like to state that because core inflation is presently very low, it gives governments the ability to continue to print and stimulate more. It is likely we will see more stimulus before a health solution solves the problem, and more stimulus should drive stock prices higher again.

Some people have been telling us this stock market feels like bubble. They cite similarities to the dot-com bubble of the late 1990’s. To answer this we are going to hand over to Mike Dwyer of Cannacord Genuity. Mike is a veteran analyst and strategist who expects rotation into more economically sensitive areas of the market from the current leadership of tech and health care:

Here is what Mike had to say on the topic of similarities to the dot-com bubble.

Dwyer’s Summary: “While many fear the current environment is like the 2000 “dot com” bubble, the macro backdrop suggests otherwise. We believe the combination of incredible monetary and fiscal stimulus, historic excess liquidity, a synchronized global economic recovery, and significant underperformance of the economically sensitive areas set the stage for a long-term rotation into the Industrial, Financial, Materials, and Consumer sectors. In our view, if the mega-cap “stay at home” stocks are still leading over the next six to twelve months, it would mean the economy is still largely shut down, which would likely create a very negative backdrop for credit. Given the historic issuance of credit, a very negative outlook for credit would bring about significant market risk. There are factors that could create increased near-term volatility, including profit taking in the mega-cap stay-at-home stocks, the coming election, talk of tax increases, and escalation in tension with China, but we believe our core thesis and the very different macro backdrop vs. 1999 suggest any pullbacks should prove temporary.”

Well said Mike. We agree with him and are now looking for those economically sensitive stocks to add to our portfolios.

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