Stock Market Updates from 5i Research - Feb 16, 2021

Chris White Feb 17, 2021

Website Maintenance - February 18

We will be undergoing routine website maintenance on Feb. 18th at 6PM EST.  The site may be unavailable for up to four hours starting at 6PM. We appreciate you patience over this period. 

New Report

We have published a new report on Dye & Durham, another notable Canadian technology company that focuses on legal and compliance software. This company is set to benefit from increased migration of internal processes to electronic documentation and searches at law firms and government offices.

Log in here to read the report! 

Report Updates

We have report updates on Magna International (MG) which received a rating upgrade due to effective cost management and a strong global position that will allow it to benefit from an economic recovery as well as more manufacturing of electric vehicles. Log in and read the reports to see our thoughts.

Read the latest updates by logging in here!

Market Update

We are just over a month into 2021 and markets seem to be cruising along with the S&P500 up ~4% and the TSX even higher at ~6% year-to-date. The recent upbeat market seems to be reflecting an expected $1.9 trillion Biden stimulus package that will support the US economy, an expected economic recovery and continued vaccinations. Corporate earnings seem to be coming along quite well with strong year-over-year improvements with many beating estimates. We have also seen stocks being more negatively impacted by small quarterly misses. We think this makes sense in a market where investors are 'pickier' than usual about which companies offer the most growth. This may be due to higher overall returns seen in the stock market, 'high growth' expected from certain popular themes like SPACs and EV stocks, or even the psychological effect of seeing 'meme stocks' go up >100% on a daily move. Regardless, investors holding a stock that may have seen a downward move recently due to a miss in earnings or lower than expected guidance should continue to focus on the fundamentals and long-term prospects of a company.

How negative interest rates + a pandemic = inflated stock market

With everything going on, the topic of low or negative interest rates may not have been on an investor's mind, but we think it is still an important factor to consider as part of the current economic backdrop. Higher household savings coupled with more money circulating in the economy also gives good context for a seemingly inflated stock market.

You may recall seeing an article here and there online drawing 'similarities' to the tech bubble of 2000. First of all, financial news media thrives on negative news so we would always take these articles with a grain of salt. Secondly, interest rates were not nearly as low as they were back then. Lastly, valuations for tech stocks today are much more justified given their high profitability and growing revenues compared to tech stocks in the 2000 bubble, some of which had no revenues, let alone profits. 

You may have heard before that low-interest rates is a positive thing for the stock market because business can borrow money at very low rates to expand their businesses without getting into too much trouble with interest payments. However, it's important to consider what effect low or even negative interest has on consumers in a pandemic, many of whom are investors. 

The idea of negative interest rates is sometimes difficult to conceptualize. A simple way to think about it is that it is meant to encourage spending and discourage saving so much that one begins to lose money (or has to pay) in order to save or lend it (by purchasing bonds). Low or negative rates means consumers are more likely to spend their money, which helps with economic activity and increases corporate profits. However, due to stimulus checks and potentially more savings, consumers have also become investors during the pandemic. After all, everyone just wants their money to be put to good use!

The combination of people staying at home, having fewer places to spend their money, having more savings lying around and watching stocks rise has very likely introduced many consumers to the stock market. And yes, this may be driving stock prices higher, and this is why the market panicked during the Reddit trading frenzy, but we do not think this paints a full picture of what is happening in the stock market as a whole.

Since bonds or savings accounts yield less and less, investor capital has naturally migrated towards stocks (and real estate), which is why we continue to see this inflation in asset prices. Of course, consumers are not the only ones with excess capital from central banks and corporations may also have extra cash they are reinvesting into their businesses, which of course encourages investors to invest them more.

Finally, with the dollar amount in bonds with yields below zero at an all-time high (see chart below), institutional investors are more likely to care. Pension funds hold a lot of our global economic capital and with interest rates so low or negative, they are likely to sell more bonds and move them into equities. This big shift in capital may even provide more support for the stock market in the long-term.

All of this is not to say that markets are immune to a correction, rather this is just to explain why we do not expect a severe one like in March of 2020. 

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