Four reasons why the stockmarket rally is not over

Those who worry that the extraordinary stock market rally will come to an end in 2022 may be worrying too soon: equities could still power ahead, and particularly so in Europe.

Stock markets have defied gloomy expectations from early 2020, when the Covid-19 pandemic began, and rallied — largely propped up by generous economic stimulus from governments and central banks.

As these policies are beginning to be removed – central banks have announced various measures to gradually withdraw their support – fears of ebbing stock markets are increasing.

But even in the absence of central bank and government stimulus, there are other factors that could still support stocks. Here are some of them:

Consumer prices are going up

With inflation at levels not seen for decades, it is easy to think the good days are over. However, there are positive effects of inflation, and an increase in stock prices for some companies could be one of them.

There are two reasons why stock prices could rise due to consumer price inflation. The first one is the most obvious: investors would move from bonds into stocks as returns from bonds decrease because of increasing interest rates.

The second reason why higher inflation could lead to higher stock prices is that some companies could use inflation to their advantage.

For a very long time, businesses have been under pressure to keep a lid on prices due to tight competition, and their profit margins have suffered.

With inflation becoming “normalised”, they can perhaps increase these margins – as long as price rises don’t get out of control and consumers are willing and able to bear them.

Investors are still flush with cash

Government stimulus, but also the restrictions imposed during the pandemic have left people with a lot of money they could not spend.

Yes, part of it went into the stellar demand (and consequent shortages of various goods and services) we have seen since the reopening of economies in the summer, but part of it is still lingering in bank accounts.

Analysts at Deutsche Bank point out that since the beginning of the pandemic, “household savings rates have been extremely elevated in absolute terms and even more so considering that household wealth has soared, which historically was associated with lower savings rates.”

Around $1.0 trillion of these household savings went into stock markets but, unlike in 2009, when as the stock market rallied assets in money market funds declined sharply, they have remained relatively constant this time.

Money market funds saw big inflows in the first quarter of 2020 amid investors’ panic about the pandemic’s effects on the economies. The fact that they did not decline as money went into stocks suggests investors still have some dry powder.

“A key upside risk in 2022 is if these savings are deployed either to support spending and therefore corporate earnings, or into equities and other asset classes directly,” the analysts at Deutsche Bank said in a recent report.

Earnings and stock buybacks

Many companies are flush with cash too, and don’t forget that real interest rates are still deep in negative territory and will most probably remain there for a while.

If the Omicron variant of the coronavirus proves to be indeed less harmful than Delta and rings the end of the pandemic, companies could ride a wave of surging consumption, which is likely to push their earnings to new highs.

The real negative interest rates mean that it is still quite cheap (in fact, it makes sense) for companies to borrow money and use at least part of it to buy back shares.

The analysts at Deutsche Bank expect share buybacks for companies in the S&P 500 index to increase by more than 10% to more than $1.0 trillion next year.

Appetite for stocks

Since news in November 2020 of the manufacturing of efficient vaccines against Covid-19, equity inflows have totalled almost $1.0 trillion – an “enormous” amount, according to the Deutsche Bank analysts, and “easily the highest on record over any year.”

But looking at the details, scaled by the overall assets under management, they are “at the top but within the range they have been in over the last decade, and well below levels seen in uptrends prior to that,” the Deutsche Bank analysts note.

What’s more, these inflows come after several years of weak capital flows, with cumulative inflows into equity funds flat for about a decade before the pandemic.

Looking at regions, the US took the lion’s share of investors’ newly found love for stocks: of the approximatively $900 billion invested in equity funds in the last year, $270 billion went into US stocks, $121 in emerging markets, $2 billion in Japan and the rest went into funds with international mandates.

By contrast, European stocks saw $1.0 billion going out in the past 12 months. This means there is probably big potential for European stocks to catch up in 2022.