These Stock Prices Are Crazy, Right? Not So Fast

Why is the market still rising like a fresh birthday balloon?

Following a strong recovery and new highs in 2020 (where the stock indexes confounded all the pundits), one would expect the market would be due for a big drop. After all, there was a sweeping political change, taxes and regulations are headed North, and the economy isn't exactly back to pre-pandemic levels.

Those are important stories. But there is a bigger story.

We’ve got three opinions and a bonus:

First, stock prices move early: The market is a discounting mechanism, which means stock prices will move in front of economic activity. We expect the US economy to grow between 5-6% this year, with a very significant earnings rebound for companies in the S&P 500. Today's price is a guess at data 6-12 months out.

Secondly, interest rates are roughly 0% everywhere you look. The yield on checking, savings, and bond investments is still historically at very depressed levels.

This makes investments in stocks much more attractive. People are willing to take some risks to make money, rather than have a guarantee it will rot in the bank and lose to inflation.

The price-earnings ratio, which is a common valuation measure for stocks, gives us an interesting insight into this:

If you were to put a price to earnings ratio on the 10-year treasury (at 1%) it would be 100. You pay $100 for every 1$ of income.

The P/E ratio on global stocks is about 20- that is to say, your $100 investment in stocks generates about $5 in earnings.

Stocks aren't the only benefactor: Real Estate, Bitcoin, Artwork, Classic Cars, and even Sports Cards are seeing speculative buyers looking for quick profits.

Third is the abundant amount of liquidity in the economy. $10 Trillion in stimulus and Federal Reserve measures will do that. Money market deposits, checking deposits, and savings accounts are at record high levels. Inevitably, some of this money will find its way into the market seeking higher returns. The government is doing all it can to encourage this investment behavior to bolster the economy.

Bonus round: The public is falling in love with trading stocks again. Investor confidence seems to be at its highest level in years. We don't have any data on this, it's purely anecdotal. But sharing stock trades by the water cooler or at the cocktail party seems to be in vogue. Several new investors we've met are looking "to get in the game".

So these three factors: higher earnings, low-interest rates, record amounts of liquidity are driving stock prices higher, along with a cool factor for doing it.

Does this mean stock prices will continue to move up uninterrupted forever? Of course not!

We will get corrections (as we always do), but the trend that is in place favors higher prices moving forward. And while investing at all-time highs doesn't feel great at the moment, markets can trade above what you believe are "fair prices" for several years.

Besides, if the market continues its long trend of up-and-to-the-right, today's highs might be next decade's deep discounts.