Traders work on the floor of the NYSE on Sept. 26.Spencer Platt/Getty Images
It’s a nerve-wracking time to have money riding on the stock market.
Bonds are flashing stress signals. Higher borrowing costs are bearing down on a world awash in debt. The oil shock in the Middle East is reigniting inflation. Superintelligent machines are apparently coming to obliterate the human race. And can you believe these gas prices?
It’s tough to shake the feeling that something is about to break. A steady supply of bearish commentary adds to the sense that a golden age for investors is nearing its end. Did you hear that U.S. investor Michael Burry, famous for betting against Wall Street prior to the global financial crisis, has just moved up his timeline for the AI crash?
What’s not being talked about much any more are the excellent reasons to stay invested. Stock valuations have been dropping for the past year, for example, and not just by a little bit – hardly what you would expect to see in the middle of a speculative frenzy.
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“Technology equities have not experienced a classic bubble because valuation levels are much lower than in previous financial bubbles,” Goldman Sachs analysts wrote in their latest strategy note.
Plus, corporate earnings are booming globally. And balance sheets are generally healthy.
Before you get spooked out of the stock market altogether, consider the positives.
The stock market has gotten cheaper, even as major indexes have climbed higher
There are two forces, broadly speaking, that drive the stock market higher over time. Either the companies in the index in question make more money. Or, investors collectively decide they’re happy to pay more for each dollar of those earnings. Or both.
When things get really nutty, the investing masses become willing to pay virtually any amount, sending trading multiples through the roof. This is the classic bubble scenario. That’s not what’s happening now.
So far this year, the S&P 500 index has risen by 12 per cent. Earnings contributed about 24 per cent, while declining valuations were a negative force, to the tune of minus-12 per cent. So, the market has become more affordable even while continuing to ring in record highs.
The same is true on a global scale – flat or declining valuations. We can take this as a sign of investor restraint, rather than the kind of exuberance that can get us all into trouble.
A surge in corporate earnings is helping to underpin stock prices
We are witnessing a corporate profit cycle more powerful than anything in recent history. The effect is most pronounced in the U.S., where S&P 500 earnings are expected to rise by 34 per cent this year over last.
But on the earnings front as well, the effect is global. In all major regions, corporate profits have been the main driver of stock returns for the past year and a half, according to the Goldman Sachs report.
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Could earnings themselves be in a bubble? It’s happened before, most notably among U.S. bank stocks in the run-up to the global financial crisis. They were overleveraged and overexposed to the housing boom, which dragged down financial sector earnings when the whole thing collapsed.
That doesn’t seem to be the case this time around. Earnings are robust, debt is manageable, and demand for computing power is way outstripping supply. “The bottlenecks are increasingly power, land and data centre capacity rather than a lack of compute demand,” Goldman Sachs said.
Corporate balance sheets offer a cushion against higher borrowing costs
With interest rates trending higher, the concern is that borrowing is getting more expensive at the same time as the corporate sector is spending frantically on the AI buildout.
But an abundance of research points to plenty of financial breathing room. The U.S. Federal Reserve said in July that publicly traded businesses generally have plenty of cash flow to service their debt.
Plus, tech sector debt loads are lower than they are for the S&P 500 as a whole, according to a recent report by the U.S. Securities Industry and Financial Markets Association.
Maybe this stock market is not quite as scary as it seems.
Mind you, investors shouldn’t consider this a case for going all in on stocks, any more than Michael’s Burry’s doomsaying should compel them to liquidate their investments.
The point is, you can still participate in this stock market bonanza without risking your neck.
