Welcome to the ‘Everything Rally’ – the prospect of a rebound in the global economy has fuelled optimism despite the economic damage from the pandemic.
The markets have become too hot to handle. So intense is the frenzied stock-buying that even many of Wall Street’s biggest brokerages and wealth managers are struggling to keep up. Almost every major US brokerage firm — from old stalwarts like Charles Schwab and Merrill Lynch to new platforms such as Robinhood — suffered at least one outage in November.
Retail investors led the dramatic equity market recovery from the Covid-19 shock, but now they are increasingly joined by the investment industry’s heavyweights, which are helping reinforce and broaden out the most remarkable bull run in financial history. The MSCI All-Country World index climbed another 12.2 per cent in November — its best month on record — to touch new all-time highs. The gauge has added $30tn in market capitalisation since the March lows.
Moreover, this stage of the rally has been mainly powered by corners of the market largely left behind during the pandemic, such as energy stocks, airlines, hotel groups, European banks, smaller US companies and emerging markets. Indeed, it has become what some analysts have termed an “everything rally”, with junk bonds, copper, oil and even bitcoin climbing sharply. The only major markets to have taken a hit are classic safe havens, such as US Treasuries (with the 10-year yield up to 0.95% yield-to-maturity – up from 0.76% a month ago) and gold (at $1800 per ounce -down from recent $2,075 high). Worth also mentioning that the US Dollar, which is seen as a safe haven asset, is at its lowest level versus its peers since April 2018.
Why the Equity Market Euphoria?
November’s shift from optimism to near-euphoria has been triggered by an alignment of several stars.
1) First, Joe Biden won the US presidency but Democrats failed to gain control of the Senate. For many investors that was close to the perfect result, ejecting the erratic, norm-shattering Donald Trump but stymieing the more radical parts of the Democratic agenda — such as heavy corporate tax increases. While another big dose of fiscal stimulus may be trickier to pass, this will mean that the Federal Reserve is more likely to keep its foot on the monetary pedal. “Gridlock is Goldilocks,” was the pithy title of one Wall Street analyst’s note on the subject. That President Donald Trump’s refusal to accept the result has failed to trigger any significant unrest has added to investors’ relief
2) Then, BioNTech-Pfizer, Moderna and Oxford university-AstraZeneca announced that they had developed coronavirus vaccines that were in most cases more effective than expected. This provided an enormous jolt to global markets, which could contemplate a gradual economic normalisation next year, with pent-up demand and super-easy monetary policy fuelling a huge growth spurt. Reports of corporate profits rebounding have reinforced the optimism.
3) And to cap it off, last week it emerged that Mr Biden would name former Federal Reserve chair Janet Yellen as his Treasury secretary. That raises the prospect of co-ordinated and aggressive fiscal-monetary policymaking to combat the economic damage wreaked by Covid-19, further delighting investors. Some refer to Ms Yellen as the “Fairy Godmother of the Bull Market” when she was chair of the central bank in 2014-18, due to her dovish views, and reckons her re-emergence as an influential policymaker is another positive sign for equities. All this on top of a base of extraordinary aggressive stimulus measures over the past several months that continue to send money sloshing around the financial system.
The combination of factors has been electrifying. Fund managers have not been as hopeful that economic growth and corporate profits will improve since 2002, according to a widely-followed Bank of America survey. Their cash reserves have dropped by 1.8 percentage points in the past seven months — the fastest slump on record — to nearly 4 per cent. The survey showed that fund managers’ optimism on stocks has jumped to the highest since early 2018, when markets were basking in the glow of Mr Trump’s corporate tax cuts.
The frothiness has moved out into pretty much every measure of market sentiment.
Prospective Treasury secretary Janet Yellen is expected to push for more stimulus from Federal Reserve chair Jerome Powell. Investors are also pumping more money into fund managers. Equity funds have globally hauled in nearly $90bn since the beginning of November, after the strongest three-week stretch of inflows on record. Goldman Sachs estimates that “short” positioning on US stocks — bets on them falling — is the lowest since at least 2004.
Investors have not only propelled many major equity market indices to record highs, the November newsflow has triggered a seismic investor “rotation” away from stocks that were seen as Covid-era winners and into beaten-up industries that are more closely tied to the health of the global economy. What was once a one-engine rally — with Big Tech providing virtually all of the vim — has seen markets fire on almost every cylinder in November. European bank shares and global energy stocks had lost about half their value by the March nadir, and have since largely languished. But in November they soared 30 per cent and 35 per cent respectively. Airline stocks jumped more than 30 per cent. The Russell 2000 index of small US companies climbed more than 18 per cent, almost twice the gain of its “big brothers”, the S&P 500 and the Nasdaq 100 indices.
Emerging market stocks rose more than 9 per cent in November, the biggest monthly gain in nearly four years. Junk bonds have almost clawed back all their 2020 losses.
What could go wrong? Consensus Fears
Normaly when everyone thinks the same way i.e. stock prices are a one-way bet, that is a very dangerous time in the market. What could change the current strong bullish sentiment?
1)There is a danger that stimulus-soaked, vaccine-happy markets may be becoming oblivious to both the immediate economic dangers that continue to linger, and the enormous longer-term damage the pandemic has already caused.
Although the development of effective vaccines is unquestionably positive, some economists point out that it will take up to a year to produce and distribute enough of the vaccines to inoculate most of the world. In the meantime, the second coronavirus wave is threatening to unravel the summer’s economic recovery.
2) Europe’s renewed lockdowns mean that all of the region’s major economies are suffering another contraction, according to Deutsche Bank. In the US, last week’s Thanksgiving holiday could turn out to be a “super spreader event” that ultimately leads to another downturn in the first quarter of 2021. The looming Christmas holiday could become an even bigger Covid spreader for many other countries.
3)Two remaining Georgia Senate seat elections in January could also upset markets, some analysts note. If the Democrats triumph, the party would in effect enjoy control of both executive and legislative branches. That would likely lead to a heftier stimulus package, but put corporate tax hikes and more aggressive regulatory moves back on the agenda, potentially wrongfooting markets.
4)Conversely, governments refusing to countenance more stimulus and ratcheting back public spending too quickly — as happened in the wake of the global financial crisis — might sap the market rally of its vim, other analysts caution.
The IMF has pencilled in a 5.2 per cent expansion for the global economy in 2021. But with an economic recovery already baked into stock markets, even a modest disappointment next year might upset markets.
5) Moreover, equity markets may be damaged if bond yields continue to climb higher — perhaps spurred by a long-forecast acceleration in inflation in 2021. Stocks benefit hugely from low bond yields, both due to the miserliness of the prospective returns of fixed income and because they directly feed into how investors value the future earnings of a stock. Rising bond yields might make fast-growing technology stocks — which have dominated returns this year — seem particularly frothily valued.
As an industry veteran said last week “While we have this euphoria, it’s pretty hard to imagine the bubble breaking, but you look at the economic and CV 19 data you think this thing could go (asset price burst) next week.”