Why is the stock market is going up despite slow growth? Share markets at the moment do not seem to make any sense to the average investor. The S&P/ASX 200 has almost hit its highest point since 2007 yet economic growth has been subdued for a while. So why has the stock market been so bullish when the economy has been weak?
1. Low interest rates
Investors are looking for asset classes which generate high returns. Low interest rates mean government bonds were returning very low rates of returns. Bank deposits don’t do much better with interest rates being at all-time lows. Property has also seen the peak so investors with capital were seeking higher returns for their money. The share market looked to be the highest yielding asset class compared to other asset classes and this has created the rise in stock prices as popularity of equities increased.
One of the reasons for lower rates is the low rate of inflation. Inflation has been lower than targeted so the central banks have lowered interest rates in the hopes of stimulating the economy. Lower rates mean lower borrowing costs which is good for stocks. The expectation of a weakening US economy will encourage the US Federal Reserve to cut rates. Lower interest rates created optimism in the stock market. The market is not concerned about recession it is more concerned about interest rates.
2. Liquidity – Quantitative easing
Demand for stocks is increasing as per the first point on low interest rates and the stock market is generating higher returns. As demand for stocks increases, then prices for stocks increases as well. There is also an increased supply of money in the stock market from quantitative easing. This has created more credit for banks and in effect has encouraged them to lend out money to businesses and individuals which has contributed to strong market performance.
3. Earnings growth for companies
Earnings for companies have been positive even with the weakening economy. Last Australian reporting season saw 29 per cent of companies report missed expectations but 70 percent of results were in line or better than expected. Only 5 stocks were downgraded and 16 stocks were upgraded. Hence companies have been performing to expectations despite the slow economy. This has in effect assisted the stock market rally.
4. Share markets are forward looking
The prices of stocks in the share market reflect what investors think is going to happen in the future. In the US market, investors are not worried about a recession, as they are confident the US Federal Reserve will keep interest rates low in line with slowing economy and this is keeping the stock prices higher.
Lauren Hua is a private client adviser at Fairmont Equities.
Would you like us to call you when we have a great idea? Check out our services.
Disclaimer: The information in this article is general advice only. Read our full disclaimer HERE.
Like this article? Share it now on Facebook and Twitter!