What drives the overall market? Following a modest sell-off in September, stocks racked up a big gain in October, with the Dow Jones Industrial Average and the S&P 500 Index setting new highs late in the month, according to market data provided by the St. Louis Federal Reserve.
The S&P 500 turned in its best monthly performance of the year, while the Dow managed its best return since March.
While October’s rebound is encouraging, let me caution that I want to keep you focused on your longer-term goals. Stocks have historically had a long-term upward bias, but they don’t move in a straight line, no matter how positive the economic fundamentals may be.
Be that as it may, 2021 has been a very good year for investors.
For the layperson, viewing the multiple highs we’ve seen this year can spark questions. One may ask, “Why are stocks performing so well? Aren’t we still in a pandemic? Isn’t inflation a concern? Aren’t we facing economic and political challenges that should derail the rally?”
All are good questions. All are fair questions.
But various metrics that investors collectively follow vary from what the casual observer might be more attuned to. And by investors, I mean the millions of large and small investors that buy and sell equities on a regular basis. Let’s look at three variables that have played an outsized role in this year’s rally:
They have all been strong tailwinds for stocks.
Economic growth slowed in the third quarter, but overall, it has been strong this year. Economic growth by itself might not be an important variable, but economic growth powers profit growth. And investors are very attuned to what happens with profits.
The pandemic has created enormous economic distortions that have benefited some sectors at the expense of others. I get that. Overall, however, the economic rebound has fueled a substantial increase in earnings this year, according to Refinitiv, and that has aided equities.
Notably, October’s strong performance was closely tied to another quarter of much-better-than projected Q3 profits (Refinitiv).
Think of it like this. If you find a small business that you might want to purchase, you’d examine many aspects, but current profits and expected future profits would play a big role in the final purchase price. The same line of thinking holds true for publicly traded companies.
Let’s add one more variable to our recipe: interest rates. Interest rates and bond yields are at very low levels. Without jumping deep into the weeds of time-tested academic research, low interest rates leave savers with fewer options. In turn, that makes stocks more attractive to savers.
I’ve said before that we’re due for a correction of at least 10% - 20% anytime. Obviously, that did not happen in October, as favorable economic fundamentals countered September’s uncertain mood.
Yet, risks never completely abate, even if they are overshadowed by favorable developments. Inflation is still a worry, and investors now expect a faster pace of rate hikes from the Fed, according to a recent CNBC survey.
Even if the Fed were to go ahead with one or two quarter-percent rate hikes next year, the fed funds rate would remain near historic lows.
I trust you’ve found this review to be educational and informative.
Let me emphasize that it is my job to assist you. If you have any questions or would like to discuss any matters, please feel free to give me a call.
As always, I’m honored and humbled that you have placed your confidence and trust in me to serve as your financial advisor.