I am getting increasingly acclimated to the acronyms that matter these days, especially the ones that explain exactly why the equity markets are on fire. I wrote about frothy equity markets in July in E-MorningCoffee, searching for an explanation as to why at the time the S&P 500 – which was then at a record high Schiller P/E ratio (or at record highs using almost any other valuation metric you might choose to use) – had risen so far and fast since the onset of the pandemic, just 18 months ago. You can find that article here: “How did we get here: US equities are expensive”. Since I published that article on July 27th, the S&P 500 has increased another 6.4%, closing yesterday (Nov 22nd) at 4,682.94, only slightly lower than its record close (and 66th record close this year) on Nov 18th.
Here’s what the trajectory of the S&P 500 looks like graphically since March 23rd, 2020, the low point of markets as the pandemic became a reality.
That’s incredible performance any way you slice it. Many investors have stayed almost fully invested in equities, and I include myself in that camp. However, I will admit that my anxiety level is rising quickly because I can’t find any fundamental support for the price of many stocks today. I recognise that this is my shortcoming perhaps as an investor. I am unable to shake off a traditional approach to valuing stocks and adopt a momentum mentality wrapped more around today’s technical factors which seem to be the drivers. At least I am smart enough to step outside my logical self and try to understand why. There are three acronyms that can perhaps explain why we are here today, and why we very well might keep going higher. Dovish policies of the Fed then provide the icing on the cake. FOMO, or Fear Of Missing Out: The meaning of FOMO is simple. Everyone seems to be making gobs of money in risk markets, so you have to be invested. With the S&P 500 having returned 29.8%, 16.3% and 24.7% in 2019, 2020 and 2021 YtD, respectively, being out of equities would have meant a healthy opportunity cost. And if you’re invested in equities but have missed out on the FAMAG stocks, or some of the other large cap hot stocks – like TSLA, NVDA or SHOP – or some of the smaller but fast-running high-flyers (many unprofitable), you might consider being underinvested in these names as a painful opportunity lost. And have you missed out on crypto’s? Bitcoin was at $3,743 at the beginning of 2019 and is at $56,374 today, a CAGR of 155%/annum over less than three years. Yikes – it has been costly not to have been invested in risky assets, and you don’t want to miss out on these returns!
TINA, or There Is No Alternative: If equities, cryptos and the like make you nervous at the moment, then what are you going to do with your cash if you lighten up? Government bonds (e.g. US Treasuries) have scant nominal yields and negative real yields. Corporate bond spreads are at record lows. In fact, bonds across the board have a negative bias, more likely to go down in price than up as pressures continue on yields and inflation looks persistent. Gold has gone nowhere fast and offers no current return. Banks pay near 0% interest on deposits (if you’re lucky) and CDs. Aside from alternative assets (which are difficult to evaluate for me), there’s simply nowhere to go to have a chance at generating the juicy returns offered by riskier asset classes like equities. YOLO, or You Only Live Once: Let me say this another way – “go big or go home”. And if it doesn’t work out, there is always tomorrow and another idea. This sort of thinking might mainly characterise Gen Z investors and / or those with limited financial obligations (e.g. no mortgage, no children costs, etc), but it is a growing and loud contingent, often expressing ideas and rallying support on social media forums like Reddit and Twitter. It is characterised by a risk tolerance that – at least from my vantage point – enables these investors to make large wagers on risky assets that might generate huge potential payoffs or might result in huge losses. This is understood and if it all goes wrong, so what? I think this attitude also encourages the use of leverage on long positions, whether that means margin finance or options, especially since the cost of leverage is nearly nil. The Fed: No new news here, but you have to love the Fed if you like risk, since the central bank has charted a course for easy money for months to come. Many investors and economists are laser-focused at the moment on inflation of goods and services, especially given that the last CPI print in the US was 6.2%. However, there is equally relevant inflation occurring in financial assets, the riskiest of which have seen their prices increase indiscriminately since just after the onset of the pandemic. Leverage is cheap and readily available. As the prices of financial assets go higher and higher, investors are emboldened to take on even more risk. Even if the Fed were to tighten sooner than expected (unlikely), I am not sure that slightly higher margin borrowing rates would immediately curtail risk-taking. Rather, undoing this cycle will require the Fed to be sufficiently bold to fundamentally alter its approach, and this would undoubtedly risk sending the US economy into recession. Will the Fed be strong enough to do this? I’m not sure it will anytime soon, because the Fed seems stuck between a rock and a hard place in determining how and when to tilt towards a more hawkish stance without wrecking the economy. This is the technical context in which we find ourselves at the moment. If you are concerned, then “SEGO”, my own acronym for “sell everything, get out”. Having said that, you only live once!
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