What is actually driving the equities bull run?

Thursday, 31st October 2019 11:14 - by Rajan Dhall

The S&P has just hit all-time highs and although the FTSE 100 is lagging the indices often follow each other.

Quantitative easing has been all the rage amongst central banks and lower interest rates are also a key theme of 2019 and the FOMC just cut by 25bp yesterday. 

This essentially means that corporations get less for their deposits in terms of interest but lending is very very cheap.

This has caused huge problems. Lower interest rates are supposed to push investors into investing in the economy. But this is a catch 22 situation, lower interest rates mean central banks are easing to grow the economy. Why would you invest if you have no confidence in the economy?.

The QE was supposed to be used to add liquidity and make the companies invest in their businesses to grow.  What we have seen is share buybacks grow at an alarming rate.

So has the rally been due to the companies performing well or less supply of shares on the market? The chart below from data stream shows that The S&P 500 has rallied despite underlying profits joining them in that really. 

As a technical analyst, this bothers me. Equities are making higher lows and higher highs but the divergence between the index and the performance of the companies is alarming.

Although this chart shows the similarities between now and the price drop in the late 1990's we are in a very different situation. The markets were not being propped up by central bank easing then.

This chart shows the sheer amount of share buybacks we have seen over the past 10 years. The price of stocks clearly has been pushed higher by the phenomenon of buying back your own shares with cheap lending. It's fair to say after 2008-9 the market needed it the financial crisis hit corporations hard. 

Lastly, this chart shows the US corporate debt in relative terms compared to the US GDP. Although US GDP readings are relatively positive at the moment you need to measure the impact of the companies performance in earnings against the debt they carry. 

Now it might seem like scaremongering but I am forced to wonder how long this situation can last.

The Bank of Japan started investing in ETF funds directly along with the Swiss National Bank. This looks like a failed experiment as just yesterday it was reported that the BoJ will now have to lend these products back to the brokers in order to increase liquidity in the market place. Now imagine that a central bank owning 80% of all ETF funds! 

I have been working in the financial markets for a long time and consider myself a sceptic but how can you fight this never-ending rally in stocks. My old boss kept telling me the Nikkei would have to pull back at some stage but we have been waiting over 6 years! 

If we bought the Nikkei back then we would be up 40% on a buy and hold. My advice is to look for the signs. As a technical analyst when the equities markets start to turn we will see lower highs and lower lows on the weekly charts. Until that point, there is no use in fighting the power of this ultra-loose monetary policy. Just be aware of the warning signals from the charts above and maybe buy some gold or gold-related stocks as part of your portfolio. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.