(Singapore, 29 September, 2020) – The US stock markets are the best performing markets by far compared with the markets of the rest of the world. Yet, the underlying US economy is lagging behind. What’s driving the US stock markets? Are the markets likely to sustain their upward momentum post-Covid 19? Is it a good time to buy into these markets? Mr Sani Hamid, Director of Wealth Management (Economy & Market Strategy) with advisory firm Financial Alliance, presents you the story of the US stock markets in 10 charts below:
Chart 1: The best performing stock market by far
Since the Global Financial Crisis of 2008, the S&P500 has led other major stock markets. Over a 10-year period to Aug 31, 2020, the S&P500 has grown an annualised 11.5% versus Europe’s Stoxx600 2.0% and MSCI Emerging Market’s 0.4%. The STI has clocked an annualised loss of 2.2% over this period.
Source: Fundsupermart
Chart 2: The US economy wasn’t the main reason for Wall Street’s strong performance. While the US economy did relatively well when compared to other developed economies, it’s performance relative to post-recession periods throughout history suggested it was experiencing the slowest post-recession expansion ever. So, if it wasn’t optimism over economic growth, what propelled the US stock market to outperform so strongly?
Source: https://www.forbes.com/sites/randybrown/2018/08/14/with-4-1-us-gdp-growth-what-comes-next/#13e1d22c342d
Chart 3: Much of the stock market’s gains were due to the massive injection of liquidity by the Federal Reserve via Quantitative Easing. During the 2009-2015 period, in response to the GFC and its aftermath, the Fed initiated several rounds of QE which led to its balance sheet (assets) rising sharply from less than $1 trillion to more than $4 trillion. The majority of the increase was in the form of mortgage backed securities (MBS) which the central bank took off the balance sheets of financial institutions in order to relieve them from such liabilities.
Chart 4: Coupled with low interest rates, this massive tsunami of liquidity made its way into the stock market. Interest rates, which was lowered to almost zero during the GFC, were kept low post-GFC. This forced many investors to seek higher returns from the stock market. When interest rates started to rise gradually in 2015, even more liquidity shifted from the bond market into the stock market.
Chart 5: Surprisingly, stock buybacks was the primary avenue via which such liquidity made its way into the stock market. This is when corporations buy back their own stocks from the open market, thus reducing their publicly available shares. In fact, data now show that it was stock buybacks by non-financial corporations that were net buyers of US stocks since the GFC. Other participants such as US households, foreigners, US institutions such as pensions and insurance companies, were in fact net sellers or only small net buyers over the same period.
Source: https://moneymorning.com/wp-content/blogs.dir/1/files/2019/05/stock-buybacks.png
Chart 6: Such strong stock buybacks were primarily led by technology companies. This comes on the back of the trend where employee compensation, especially for the technology sector, is increasingly becoming stock-related versus traditionally where such stock-related compensation was only reserved for upper management. For example, in 2015, Microsoft’s stock-based compensation made up around 3% of its revenue. While 3% does not seem like a lot, it works out to be almost US3 bln based on Microsoft’s 2015 revenue of US$93.6bln. But there are also arguments that “with the majority of their compensation coming from stock options and stock awards, senior corporate executives have used open-market repurchases to manipulate their companies’ stock prices to their own benefit” (https://hbr.org/2020/01/why-stock-buybacks-are-dangerous-for-the-economy). In fact, did you know that stock buybacks were in fact illegal until 1982? Until then, the Securities Exchange Act of 1934, created after the Great Crash of 1929 considered large-scale share repurchases a form of stock manipulation.
Chart 7: Thus little surprise that tech shares – especially a selected few- have led the way since the GFC. Since the depths of the GFC in March 2009, the Nasdaq has gained around 600% whilst the S&P500 a little less than 300%.
Chart 8: But it doesn’t end there. When it comes to the S&P500, when one breaks this down further to what is known as the S&P5 (Apple, Amazon, Google, Facebook, Microsoft) vs S&P495 (the remaining component of the index), it is apparent that the majority of the shares in the S&P500 have gone up very little and it has been these selected 5 tech shares that have contributed the bulk of the gains so far on the index.
Chart 9: Passive investments add fuel to fire by concentrating inflows into the hands of a few stocks. The strong growth in passive investing (via ETFs and passive mutual funds) have added to the momentum behind Wall Street’s strong performance. The move away from actively managed (by fund managers) investments to that of passive investments have almost been identical. Notably, this is exacerbating the situation as passive investments concentrate all their inflows into a fixed set of stocks (which represent an index). And in the case of the S&P500, for example, the 6 tech stocks mentioned previously together with Netflix make up 1/5 or 22% of the total S&P500. In other words, for every $1 that goes into a S&P500 ETF, $0.22 alone goes into these 6 stocks.
Chart 10
In summary, investors looking for the US stockmarkets to resume their climb will basically have to assume one or a combination of things happening: corporate buybacks and/or inflow into passive investments resuming in earnest, or a total switch from a handful of growth stocks into the broader market especially value stocks. Otherwise, without such catalysts, it is hard to see how US stocks could sustain a move higher post-COVID.-/-
Disclaimer: Mr Sani Hamid is a Director (Economy & Market Strategy) with financial advisory firm Financial Alliance and a Certified Financial Planner. He contributes to www.halaluniverse.net on a regular basis. The views, opinions and information expressed in this article are purely for education and information and are not to be construed as financial advice. Investors should seek advice from a financial adviser before investing.
