Stock market valuations can swing back and forth from one extreme to the other, sometimes being depressed and offering high value, and at other times appearing overvalued and speculative. Somewhere in the middle of this swing may be the fair value of any particular equity.
Consider how quickly the market’s pendulum changed course over just the past year. After last spring’s significant drop in the markets, in the midst of the greatest economic and public health crisis of our time, the pendulum swung to the other side. To start 2021, the S&P/TSX Composite (TSX) and S&P 500 indices posted record highs, with many stock valuations appearing stretched.
Of course, equity markets are forward looking in nature: economies will eventually fully reopen and pent-up demand is anticipated to be released. However, other factors have helped to push the markets higher. With central banks pledging to keep interest rates low for the near term, investors have turned to equity markets given a lack of alternatives. Continuing stimulus measures have also helped to inflate asset prices. A rise in low-commission trading platforms has enticed many new investors to enter the markets, often trading based on momentum.
More recently, long-term bond rates have been rising, which has increased inflation expectations. Yet, this shouldn’t be a surprise: rising yields are often seen when economic expectations strengthen. In the U.S., where the opening of the economy is, to a considerable extent, ahead of Canada, recent employment and manufacturing data has been better than expected.1 Here at home, accelerating vaccination programs continue to support the path to economic reopening — the light at the end of the tunnel we have long awaited!
Will the markets continue their climb? For many investors, there is limited value in trying to predict the near-term direction of the markets; after all, the overall success of your wealth plan isn’t dependent on calling the top of any cycle. Yet, consider that equity markets can often progress further than many believe. With growing optimism for a return to normal, there has been a rotation into areas of the markets that are expected to benefit as economies reopen. Volatility has also returned, largely in market sectors that have seen significant gains throughout the pandemic. After many months of market advances, this can be expected and may provide opportunities to put capital work as investors continue to build portfolios for the future.
For most investors, the investing journey will be a long one. With a sound wealth plan to guide us, and a portfolio built on quality, diversification, and focused on the longer-term, it should serve us well no matter where the market pendulum may swing. Continue to have confidence in that plan, enjoy the market advances and look forward: brighter days are ahead!