Is it really like 2021?
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This is getting familiar isn’t it? Another week, another all-time-high. SPX closed at 5,137, NDX is at 18,300. The most optimistic Wall Street analyst targets for 2024 were 5,100 for the end of year for SPX. We exceeded that level after just two months. Naturally, this raises the question, is it a bubble again?
Today I want to touch upon a very important topic – how sustainable is the current equity rally? And is it really like 2021?
As a good intro, I invite you to read this new piece by Ray Dalio from earlier this week. He asked himself a similar question – are we in a bubble right now?
Let’s have a look at the trend just in the past two months, since Jan 2nd 2024.
The trend is clear. Every single dip has been bought. Bad news got discounted very very quickly. Even during the seasonal window of weakness (Feb post-OPEX), a week in which we had TWO bad inflation prints. And yet, no major impact. Just buying the dip.
It’s been going like this since October 31st, really. We wrote about the impact immediately, suggesting that fiscal and monetary policy decisions were clearly bullish. Just like the FOMC meeting in December when they announced three cuts for this year. These were the triggers, and the market hasn’t looked back since. The AI narrative, a good economy implying a soft landing, and great earnings results all amplified the rally. A push up by 25% since Oct 31st. That is some impact.
But how long can this last? Surely it must be unsustainable?
Not necessarily.
The flows and the macro
Let’s try to understand this in terms of general macro flows. A lot of money entering the stock market every month in the United States is tied to 401k accounts – retirement accounts for about 60 million employed Americans. Every month the equivalent of about $300bn of this money gets invested into the stock market, which creates about a 1% upside impact on the market. These are flows driven by index-buying strategies. When pension funds are investing your savings they are buying indices and ETFs. Not just American funds, but worldwide funds as well. They are also buying bonds - a lot of bonds - but given the poor returns of bonds in the past 3 years, no wonder the funds have started to shift their positioning a bit.
Now, if the labor market is strong – and we know it is, demand for jobs is still huge – people’s retirement accounts will get consistently invested. These flows will keep being regularly invested into index funds.
If the macro situation becomes unstable, if unemployment starts to go up, then we can expect to get an effect of lower flows of index buying (people losing jobs, less money going towards 401K accounts). Alternatively, other causes of negative flows can be to have flows moving from equities into other assets like bonds. This is when investors get scared about what might be coming up – like they were during 2022 after the Fed started to hike to combat high inflation. The negative flows were triggered as everyone was expecting a recession - firms losing revenues, people getting fired. The 2022 bear market was fully justified given the expectations that a strong hiking cycle will kill the economy. Except that it didn’t. For the first time in almost ever.
A similar story of shifting from stocks to bonds was the story of last summer. After the Jul 31st QRA where the Treasury announced much higher supply of bonds than expected, bonds sold off, yields pushed to 5%, and equities sold off as well, primarily as a reaction to bond flows.
Basically, macro is still the primary underlying driver of equity and bond flows. The bond markets have been perfectly aligned (bonds still down 25-35% since end of 2021), but the stock market hasn’t precisely because the economy remained resilient. The macro picture looks much better than expected, and if people keep their jobs, keep spending, and firms keep making record revenues, there is no reason why the market should sell-off.