Stock Market Moves

Here's one way to make sense of a stock market that is defying the current economic crisis.

Stock Market Moves

Making sense of what’s going on in the world can help us live a more comfortable and more prosperous life. It’s more important than ever when everything seems so counter intuitive.

I’ve written before of how challenging I have found the current state of the financial markets. The rise in stock prices while the world economy is melting down hasn’t made much sense to me….until now.

There’s a clue in a previous post about the potential perils of the bond market. It’s clear now that a lot of people (i.e professional fund managers) share those concerns and are trying to beat the coming stampede toward the exit sign.

The pricing relationship of bond and interest rates is confusing to many but we can  distill the relative unattractiveness of bond investments into a simpler narrative.

Many large pension funds need to achieve minimum investment returns to remain solvent and satisfy their future liabilities. In decades past, these return could be generated through bond purchases because yields were high yields. If interest rates fell, they’d make even more money through capital appreciation on the bonds held.

The bond trade has been a one way ride to profits for decades now.

Now things are different.

Interest rates are at 5000 year lows and can’t fall much further. At some point the rates will reverse and that will cause bond holders to lose a lot of money. It also seems unwise to commit investment funds for a decade or so where the yield is a fraction of one per cent.

And that takes us to the stock market.

Despite the financial headwinds facing many businesses, there are some that are doing incredibly well. They have relatively low infrastructure costs, huge cash margins and are almost ‘indispensable’ in the modern age.

These are the tech stocks that are fuelling the record highs in the tech index. Think Microsoft, Apple, Facebook, Amazon, Google and the like.

Not only are these companies making piles of money, they have mountains of cash and also pay a dividend well in excess of the most popular government bonds.

In effect, these companies have become the bond investment proxy for desperate fund managers. It might be hard to justify the valuation but it’s hard to justify the valuation of almost everything at the moment.

In many respects, institutional money just has to find a home and the attractiveness of opportunities is relative to everything else that’s available.

Bonds seem to be a river of negative returns, cash will not satisfy the pension return needs and property doesn’t offer the liquidity many funds need. That leaves stocks as the most attractive and deepest pool they can park their money in.

While there will always be some much higher volatility in stock investments, there really isn’t too much else that will give the institutional investors the chance to make the returns they need.

So what does that mean for the retail investor?

My assessment is , notwithstanding we may have some big falls in stock prices ahead, the  flow of cash into the stock market means the longer term game will see record highs in the years ahead.

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