Stock Market: The Logic Behind The Rally

(Drivebycuriosity) - Yesterday the stock market climbed to an new all-time high, even that a late afternoon flash crash nipped a bite away. The S&P 500, the gauge for the US stock market, gained 8.6% year-to-date & 16% in the recent 12 months, the technology focused Nasdaq jumped 15% year-to-date and 25% y-o-y. I can understand that many investors are on the edge after these gains. But I think there is some logic behind the rally.

The rally, which started last November, followed a stagnation (consolidation) period of about 18 months. From late 2014 through November 2016 stock prices have been held back by falling oil prices, speculation on an alleged China crash, Europe`s worries and doubts about the US economy. But the pessimistic sentiment, which had suppressed stock prices, wasn` t justified. Europe`s economy is getting stronger, China keeps growing with a rate of more than 6% annually and the US economy is still solid. So the stock market needed a rally to compensate for the preceding unjustified weak period.  If you look onto a longer time period then gains are more moderate. In the recent 2 years the SP 500 gained around 16% since then, about 8% annually.

The information service Bespoke compared periods without a 10% correction since 1928 (bespoke). According to their calculation the recent period (477 days since February 11, 2016 with a gain of 33%) does not even belong into the top ten (table below). The record holder is the period from October 11 1990 through October 7 1997 (2,533 days, gain: 232%).

The recent earnings season (Q1 2017) showed that companies are doing better than many expected. Company earning are rising at least as fast as stock prices, keeping valuations reasonable (price-earnings-relations).  I believe the positive trend will continue, justifying further gains on the stock market. During the recessions of the years 2001/02 and in 2008 companies restructured and reduced costs significantly in order to survive. Now they are much fitter and more efficient than before. I believe that this learning process will continue and will translate into a long term trend of rising company profits, the engine of the stock market rally.

Companies are benefiting from a new industrial revolution: Advances in Internet, mobile computing, 3-d-printing, robotics, nano- & biotechnology and other technologies are reducing costs, raising efficiency and creating new markets. They are also receiving solid tailwinds from the emerging markets which are even getting stronger. The catching-up process in China, India, Indonesia and a lot of other countries translates into high growth in large parts of the global economy that creates continuously rising revenues & profits for global companies like Starbucks, IBM, Caterpillar, Apple and other members of the S&P 500 (world).

If the Trump administration keeps their promises and cuts taxes, reduces regulation & invests into infrastructure the rally will have long legs. It seems that the US got a new political climate which is more business friendly and less bureaucratic which is a boost for the economy & the stock market.

Enjoy!