Where were you at the turn of the millennium? When the dot-com bubble burst?
Well on Tuesday 18 August, the S&P 500 crept up by 0.23%. It was enough to bring the reading on the index to just above the previous high that it had hit nearly six months previously, on 19 February. In between those two peaks there was a fall of 33.9% to 23 March followed by a rally of 51.5%.
The obvious question is why? The USA economy today is much less healthy – in all senses – than it was in February. In the second quarter of 2020 US GDP contracted by 9.5%, while the latest unemployment reading is 10.2%. Covid-19 cases are flatlining at around 50,000 per day and there is a Congressional logjam preventing the introduction of a second economic stimulative package to replace the $2.2trn one that expired at the end of July. Throw in for good measure a looming presidential election which the (nominally) Republican incumbent is currently on course to lose and the conditions for a raging bull market appear distinctly absent. So once again, why?
Here are some plausible answers:
- Tomorrow, not today – Markets are expressing a view about the future, not the present. Look, say, 18 months out and there could be a Covid-19 vaccine that has allowed ‘normal’ life to resume. En route there will be a jump in economic output, even if it is only to return to 2019 levels.
- Technology – Comparing the performance of the Dow Jones Index and the S&P 500, the major technology companies have been the driving force of the US market indices since March. Technology has been a major beneficiary of the pandemic as the world has moved online. Five technology stocks – Apple, Microsoft, Amazon, Facebook and Alphabet (aka Google) – top the S&P 500’s constituent list and now represent 21% of the index by value. The FT estimates that this quintet accounts for a quarter of the rally in the index since 23 March.
Technology’s impact also shows through in the NASDAQ Composite Index, as the above graph illustrates. This has traditionally been heavily weighted to technology shares and is up 25% this year (against 5% for the S&P 500).
- Interest rates and money – At the start of this year, the 10-year US Treasury Bond offered a yield of 1.92% while the Federal Funds Rate was 1.50%-1.75%. Today the corresponding figures are 0.67% and 0%-0.25%.
The Federal Reserve, in common with other central banks, has not only made money cheap to borrow, but has also thrown vast quantities of cash into the markets to prevent them locking up. The Fed’s balance sheet has expanded from $4.2trn at the start of the year to just shy of $7trn now.
The UK for that matter has just exceeded $2trn!
All other things being equal – a dangerous proviso at the best of times – lower interest rates increase the value of shares because the income they produce is discounted at a lower interest rate. The historic earnings yield on the S&P 500 is now 3.43% against 4.32% at the start of the year.
- FOMO Fear-of-missing-out (FOMO) is playing its part in the rally. The USA has seen a jump in interest from retail investors, helped by a move to zero commission rates late last year. According to one report, retail investors now account for about 20% of market activity – and nearly 25% on peak days – against an average of 10% in 2019.
Tuesday’s peaks for the S&P 500 and NASDAQ prompted a number of comments from those who remember the technology boom of 1999. However, this time around the technology companies in focus are making money, not burning it.