The Real Reasons Stocks Are Hitting Highs

I speak to a lot of people, and in conversations with investors, the most frequent thing expressed to me about the current level of the major stock indices is a kind of happy bewilderment. They are happy to see stocks at or around all-time highs, but a bit mystified as to why the market is so elevated.

After all, inflation, while down significantly from its peak, has remained stubbornly above 3%. As a result, the expectations for six or seven rate cuts this year -- the thing that drove the market higher in the second half of last year -- have turned into a debate about whether interest rates should be cut at all. One even hears occasional talk of a further hike later this year. 

Then there is the insidious impact of the early ads in the Presidential election, with Republicans pointing out that the federal debt is massive and growing and suggesting that the economy is basically a slow moving car wreck, and Democrats in Republican-led states and municipalities also suggesting economic failure.

Overall, it is hard to escape the feeling that we are in bubble giving some investors a false sense of security. So, what is driving all of this? Is it actually a bubble, fueled by the government handing out money in defiance of the Fed’s attempts to slow things down using monetary policy? Or is it an inevitable result of so much cash hitting the system during a decade of ultra-low rates, money that is still seeking a return? Or might it be that things aren’t that bad at all, that our perception of an economy in trouble is wrong?

The evidence suggests that it is the latter; we may feel that things are going badly, but the facts suggest otherwise. I will take my facts over your feelings anytime.

This is about more than tech, or crypto, or whatever else people think is driving what they see as unsustainable gains. The Nasdaq, which is seen as best reflecting tech stocks, is around its high for sure, but the run up has been led by the Dow, which is more representative of industrial and manufacturing names. That isn’t the stuff of which bubbles are made. In fact, 2023 saw the highest manufacturing output in US history and so far, 2024 looks like it will beat that record.

And anyway, a “bubble,” by definition, is a move up based on speculation and froth, whereas this move is based on two solid, fundamental things.

First, Q1 earnings have been objectively good. According to the most recent blog from John Butters at FactSet’s Earnings Insight, after 93% of S&P 500 companies had reported, an above average 78% beat expectations for EPS. They are recording beats by an average of 7.5%, which is above the 10-year average for that metric, and their profits grew by 5.7%, the highest rate since Q2 of 2022. It might not feel like it, but American business is doing just fine, thank you.

Then there is the basic fact that we are at the beginning of a shift in the way we work that will result in a massive increase in productivity. AI may seem overhyped in some ways, but it is changing the way companies of every size, shape and specialty are doing business. One could argue that those changes are or will be disruptive from a societal perspective, but from a business perspective, greater efficiency, and therefore greater profitability, is coming.

Ultimately, when you consider the evidence, the surprising thing is not that stock indices are at such high levels, but rather why they aren’t even higher. That is because the current situation is being tempered by some concern for the future, and not just from traders and investors. So far this earnings season, 54 of the 91 companies that have guided for next quarter have issued guidance that was negative or fell short of expectations, with only 37 sounding positive. 

On the other side of that coin, though, as Butters points out in his most recent post, mentions of “inflation” by CEOs in their commentary fell again this quarter, making that less of a concern than it has been for a while.

Ultimately, American stock prices are reflective of the profits and prospects for profits of US businesses above all else, and on that front, things are going well, no matter what politicians’ attack ads may say or what you might feel. There is some concern going forward that is holding stocks back but, all things considered, the market looks quite fairly valued right now.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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