The strong backdrop for stocks will be there through to next year


Back to school for most, but back to business for equity markets as they continue their historic bull run of the last 18 months. The German DAX has joined the US markets in breaking to all-time highs and the CAC40 isn’t far behind. Despite some regulatory issues weighing on Chinese Equities by and large the investment backdrop for equity markets is exceptionally favourable. Record profitability, unprecedented growth opportunities and ongoing strong policy support directed at certain sectors are combining to generate strong investment returns for investors globally.

orporates are in an even healthier position coming out of the pandemic than they were going into it. Earnings have recovered to above and beyond their pre-crisis levels at a speed that is incomparable with any other recovery in history. Record profit margins have driven upgrades to analysts’ forecasts that have exceeded the year-to-date rally in equity markets. That, rather counterintuitively, leaves equity markets on a lower valuation multiple than when they started the year, despite a near 20pc surge. Whether one believes this can continue is always up for debate but at the very least it proves the exceptionally strong fundamentals that this market rally has been based on thus far.

This strong earnings backdrop has two other profound consequences which in turn add further support to the rally. Share buybacks this year in the US, which are a function of earnings strength will reach close to $900bn (€760bn) and may end up being a record year. Corporate M&A in the US year to date, which is a function of strong balance sheets and management confidence will result in over $250bn needing to be re-invested back in the market by the end of the year as listed companies use the cash on their balance sheet to take out other listed companies. The result of these two factors is a combined demand of well over $1trn for the US equity market from the actual market itself.

Policy support, both fiscal and monetary, continues to be and will continue to be very supportive for equity markets. Although the level of fiscal support from governments going forward won’t be as large as it was at the height of the pandemic in 2020, it will still be at a level far and above what had become the norm of “fiscal austerity” post financial crisis. Of even more importance however is the targeted nature of the spending, focusing on industries and technologies of the future which are over-represented in the stock market compared to the economy. Spending of 1-2pc of GDP may seem small in the context of the economy overall but for a business, when that spending is focused on your end markets it has a materially positive impact.

Similarly monetary policy wont quite be as supportive as it was in 2020 but compared to any other time in history it is still an exceptional backdrop for investors. The Federal Reserve will begin to taper some of the liquidity they inject into the system by the end of this year, but a combination of the need to reinvest maturing bonds and ongoing policies from other global central banks means that the overall global support from central banks, as evidenced by the size of their balance sheets, will still continue to grow in 2022. As no central bank will increase rates while their balance sheets are growing, interest rates will remain zero (or below) at least into early 2023. Even then the gradual rise from zero will take years. The only major central bank that had been tightening, the Chinese PBOC, is now reversing course and has already begun to cut various benchmark rates. This will add a boost to global growth in 2022.

The nuances around various policy supports can be confusing as political rhetoric smashes into financial jargon. It is critical however not to lose sight of the fact that it is very rare in history to have both monetary and fiscal policy so supportive at the same time. This backdrop is fuelling the exciting secular trends that are changing our lives every day  trends that the largest sectors of the stock market are not only exposed to, but of which they are also a central part.

Digitalisation, decarbonisation, industrial automation are but a few examples. Pfizer, Moderna, Biontech are all names that roll off the tongue now after their incredible vaccine breakthroughs and they are all listed companies. Many of these secular trends are still in their infancy. Microsoft on a recent conference call highlighted its belief that the current 5pc of global GDP that is currently spent on IT will double over the next decade, with 80pc of that workload being done on the cloud (versus 20pc now).

Although the fundamental backdrop to markets remains strong there are some bizarre occurrences which we are alive to and wary of. The price appreciation of dogecoin, meme stocks, Robinhood, non-fungible tokens and Chinese electric vehicle makers are all difficult to understand. Luckily however these more esoteric and frothy parts of the market are too small for now to destabilise the overall markets (although not too small to seriously damage individual investors caught on the wrong side). Recent examples of these mini-bubbles or fads coming and going include Tilray, the cannabis stock that in 2018 went from $10 to $300 and back down again, or Beyond Meat, the fake meat stock that went from $40 to $250 and back down again in 2019.

A historically strong start to the year can unnerve investors. History tells us that strength such as we have seen year-to-date tends to continue into the year end. The backdrop is there for it to continue into 2022 and beyond. 

Philip Byrne is chief investment officer of Merrion Investment Managers at Cantor Fitzgerald Ireland


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