Equities are having a good run. Perhaps you noticed.
Thank the now ubiquitous reflation narrative. Or, relatedly, thank vaccine optimism. Or thank central banks for ensuring that there really is “no alternative” and that it’s possible to justify virtually any multiple, no matter how ostensibly absurd, by reference to low bond yields.
The MSCI World was on track to start the new week with an eleventh consecutive gain. Not too shabby, right?
By now, most market participants have heard it all when it comes to justifications for the ongoing rally. Similarly, anyone mired in the cacophony (which is deafening at times) is well-versed in the other side of the debate, where that just means you can probably recite the myriad reasons why the euphoria doesn’t make much sense, why it’s not sustainable, and why “it’s never different this time.”
I imagine this is probably pretty daunting for new market entrants. Or at least for those inclined to believe there’s supposed to be something behind it all — something real beyond the lines on the screens. (Nihilistic Redditors need not necessarily apply.)
Indeed, this is all pretty daunting even for finance professors. I spoke to one Monday who had a laundry list of questions about Elon Musk and Tesla (prompted by an article published here). Eventually, I resorted to a tried-and-true method for communicating how the seemingly nonsensical can make sense: I referred back to several articles from autumn of 2019, when negative corporate bond yields in Europe were grabbing headlines.
In August of that year, the face value of negative-yielding euro corporate bonds was around €1 trillion. Conceptually, those companies could mint “assets.” Or something. It’s difficult to fathom. And that’s always my point when I use that example. If corporate curves can be negative, who’s to say what Tesla or Bumble “can” or “can’t” be worth?
But maybe it’s not so insane. As SocGen’s Andrew Lapthorne reminded market participants in a Monday note, “for all its complexity, the equity market is quite a simple beast; it tends to ebb and flow with the direction of profit and profits expectations.”
Expectations for corporate profits have been revised higher recently. Goldman, for example, hiked their already above-consensus forecast for S&P 500 EPS last week. Fourth quarter earnings for corporate America actually managed to grow YoY with 84% of market cap reporting. Consensus had been looking for an 11% decline headed into reporting season.
And yet, there’s still a sense in which it’s all either contrived, a game, or a little of both.
“Analysts’ EPS expectations tend to be coincident with share price changes, so it is unclear if actual economic activity is changing the EPS or whether it is due to the need to justify a higher/lower share price target,” Lapthorne went on to say, adding that “these changes are also remarkably seasonal, with upgrades seen during the reporting season and downgrades more common thereafter as companies position and then ‘surprise’ the consensus.”
Who’s gaming who? And if everyone is gaming each other, then is any of it real?
I don’t know. Nobody does. Amusingly, even when you take into consideration higher expected earnings, multiples still end up looking elevated. Lapthorne noted that analysts now see “a 30% rise in MSCI World EPS for this year.” And yet, he marveled that “the overall P/E on MSCI World is still over 20x based on these end-2021 numbers.”
That’s not terribly worrying if bond yields stay low. But some expect yields to rise, even as they simultaneously admit central banks retain the capacity to tamp them down virtually at will.
Again: Is any of it real? And if not, then why not Bitcoin? Why not Dogecoin? Why not tulips?