Why the Market Keeps Going Up and Why It Might Matter to You

Stock-Chart

I work in the stock market, although I have never written a “market” piece in this venue. So why now? Because the broad indices have steadily climbed higher for almost five years and, until recently, no one outside of those of us trading stocks all day, seemed to notice. Now I have to be careful that Tony, my tailor whose shop is across the street from my building, doesn’t see me walking, or he runs out quickly to ask me for market advice. Why does it matter? Because jobs, corporate spending and your company — public or private — can be affected.

Let’s define the key term before going further. To me, the “market” means the S&P 500. It’s based purely on the market value of public corporations, and is a broader and deeper pool of stocks than the Dow, which only includes 30 names. To be fair, this index didn’t just start its ascent; the S&P has risen an amazing 172 percent to the 1800 level from a low of 666 on March 6th 2009. The most rapid rise, which eluded most investors, still reeling from the 2008 collapse, came immediately after the nadir, with the index vaulting 83 percent by April 23, 2010.

Admittedly, there have been some scary patches amid this rise, notably the middle chunk of 2010 and the mid-summer to fall of 2011, further pummeling investors. Nevertheless, it’s hard to ignore a year like 2013, in which the market increased 27 percent in the first 11 months.

So, what are the factors behind this incredible march higher?

1. THINGS ARE BETTER THAN EXPECTED

The market is the master of anticipation; this long rally has reflected an understanding that things weren’t apocalyptic. Just to reminisce about what could have been worse: global banking collapse, falling housing prices, the impending Cyprus crash, Greece’s possible eviction from the Euro, U.S. government shutdowns (how many should we count?), downgrading U.S. and other’s sovereign debt…

Despite all of these possibilities, none exceeded the worst case and most improved. The market kept climbing.

2. SIMPLY SUPPLY AND DEMAND

The stock market is an amazingly complex organism, in which I always imagine hoards of (minuscule, for some reason) buyers and sellers colliding and then agreeing on transactions, moving prices higher or lower based on supply and demand. The Lehman collapse washed out huge swatches of individual and institutional investors who couldn’t wait to dump their shares, accepting lower and lower prices. When the market finally bottomed, with nearly invisible “demand,” the “supply” was also limited to a hardcore of stock holders happier with the shares they owned than any alternative investment. They scoffed at low interest rates, potential defaults in bonds, decimated real estate, and global devastation and decided to stay put with the stocks they owned. If someone else wanted what they had, that buyer needed to ante up.

In addition to those few intrepids, there were other forms of incremental demand. I would never dismiss the impact of the Fed’s $85 billion a month Treasury bond buying program, as arming potential buyers with cash, but I would rather focus on corporations themselves, gobbling up their own stock at a discount. From 2003-2007, major U.S. public companies accumulated significant cash which they deployed in major share buybacks from late 2009 through much of 2013. According to data collected by Yardeni Research S&P 500 companies bought back roughly $1.5 trillion of their own equity value during this period.

Of course, companies sell stock too, but almost no offerings occurred after the crash, so the net reduction from share buy-ins minus new offerings was an extraordinary $1 trillion in four years. Currently, the value of the entire S&P 500 is $16 trillion, so this buyback accounted for meaningful demand which most certainly contributed to the overall market strength.

As companies scale back their self digestion, individuals have increased their own appetite, following years of warily watching from the sidelines as the market nearly tripled. In the first 10 months of 2013, U.S. equity fund inflows have approached $100B, moving from exceedingly low yielding bond and money market funds. 2014 may be the first time in 6 years that employees add to their 401-K equity allocations.

3. REDUCED FEAR FACTOR

There is nothing scarier for many people than losing money. Fast. When the internet bubble burst in 2000, the market nosedive shook out investors, and by the time they sheepishly returned in the middle of the first Millennial decade, the real estate/subprime collapse was imminent. This time, Americans felt betrayed, angry, and broke; they stayed clear of stocks and were satisfied with just being safe in their one percent Treasury bills.

With fear as a driving force, over $1 trillion poured into bond funds between 2009 and 2013, despite very low interest rates. But as the U.S. and other economies recovered, Americans are beginning to worry less about the financial crisis and more about missing out on the Dow Jones record levels.

However, investors today can turn on a dime from risk taking to risk aversion, so that fear, while receding now, can grab hold in mere days and cause mass selling

So what now? You won’t catch me making predictions, but I would note the following attributes of companies whose stocks have risen significantly that might matter to you:

1. They are often hiring. Strong share price often reflects underlying business quality. If you are looking for a job, check the stock chart.

2. They buy other companies. Public companies use their appreciated stock to pay for other firms, so if you are trying to sell your own enterprise, look at corporations whose stock is up as potential buyers.

3. They often spend more on plant and equipment either because they feel rich, thanks to the inflated stock, or because their business is thriving. When you think about customers for your own goods and services, pay attention to those whose shares have been climbing.

Now, we’ll see in 2014 if the market has been right.