U.S. stocks are continuing to hit all-time highs this year. The S&P 500 recently crossed 4,000 for the first time, and the Dow Jones Industrial Average is approaching 35,000.
In the last year, coming off March pandemic lows, the U.S. market has increased by more than 60 percent. Small companies, as represented by the Russell 2000 Index, have risen more than 90 percent. All this is to say, the stock market is high, and many investors believe that stocks are relatively “expensive.”
For many investors, this is a concern.
Stock market valuations matter, and investors are often taught that what goes up must come down. If we want to buy low and sell high, then what are we supposed to do when the price of stocks is perceived to be high already?
Obviously, it’s better to buy stocks when they are “cheap.” After this recent run, they might seem pricey. But, there’s good reason that stock prices are high. The future is unknowable, but investors should understand that stock market prices are not arbitrary.
Although many lost jobs during the recent economic downturn, many people increased their savings. The personal savings rate is difficult to estimate reliably, but it appears to have increased while the economy was shut down.
The government put a lot of money in people’s pockets through stimulus payments, while in-person shopping and dining were shuttered. What is not spent is saved. Early evidence coming out of the pandemic suggests that people are now willing to use their savings to buy cars, go to restaurants, splurge on cappuccinos, buy the nicer purse at the department store, and “one-click” a whole slew of new purchases.
Investors are betting this increased economic activity will continue, and that has driven the prices of stocks higher. Let’s explore some different sectors of the economy and why market prices have risen.
Airlines, hotels, retailers, restaurants, automakers and entertainment companies took a beating during the pandemic. However, investors have become enthusiastic about the prospects for growth among many of these companies. Total vehicle sales for April 2021 were the highest since 2005. Retail sales have already recovered to pre-pandemic levels.
Investors are betting that revenue and profits will rebound vigorously in the coming months and years, and this potential future growth is priced in. There is a good reason the stocks of companies in these industries have risen.
Early in the pandemic, the stock prices of tech giants such as Apple, Amazon and Microsoft all fell precipitously. Everyone was nervous about what was going to happen to the economy, and there was a lot of uncertainty about the future. However, it quickly became clear that the market for big tech was only growing further. The prices of these tech companies have recovered with fervor as investors bet on continued growth.
Oil demand and prices plummeted in the middle of last summer because car and airplane travel declined so rapidly. Oil prices were as low as $25 per barrel. They have since recovered to about $65 per barrel as demand has increased.
Coming out of this pandemic-induced recession, the stocks of oil companies have risen as well. There is also a huge potential for new alternative energy companies. The prices of dirty energy and clean energy stocks alike have risen amid this perceived surge in demand, and for good reason.
Financial companies derive a lot of revenue and profit from higher interest rates. As interest rates tanked during the pandemic, bank stocks also fared poorly. After hitting a low near 0.5 percent in August 2020, the yield on the 10-year Treasury has since increased to 1.6 percent.
As the economy continues to recover and interest rates inch higher, the banks that rely on interest rates should improve financially. The stocks of banks have risen because of current growth and future expectations.
U.S. manufacturing has been struggling for decades, and the pandemic only made things more difficult as supply chains and the labor force were disrupted. This is starting to change, and the factory Purchasing Managers Index recently hit the highest level since 1983. The index of new orders and index of production hit the highest levels since 2004.
This torrid recovery will help a sector that was left for dead. Stocks of manufacturing and industrial companies have already started to rise for a good reason.
Fast pace of change
Our technological pace of change seems to be faster than ever since the pandemic began. Many businesses became virtual almost overnight. Robots and artificial intelligence continue to evolve into real businesses. Companies that live primarily on the internet attract billions of users every day.
Meanwhile, communications companies have become integral to talking with our friends and families. Tech and communications companies have benefited from this evolution, and their stocks have risen in anticipation of continued growth.
Home sales and prices have soared in the past few months, as can been seen clearly here in the Berkshires. The median home sale price in the United States increased by 6 percent from Q4 2019 to Q4 2020. The homebuilders can hardly keep up. The stocks of homebuilders and adjacent industries have risen alongside the increased demand for new housing.
The pandemic shone a spotlight on the health care industry, and health care innovation proved impressive. Pfizer, Johnson & Johnson and Moderna rolled out COVID-19 vaccines faster than previously thought possible. This all happened against the ongoing backdrop of a country that is getting older and in greater need of health care services.
The average age of Americans has increased by about 10 years since 1970. As potential demand for health care services and products rises, so, too, have the prices of health care stocks.
All this actual and potential economic progress comes with a possible downside of rising consumer prices … the dreaded inflation! Materials and real estate prices may rise, but that should benefit materials companies and commercial real estate investment trusts (REITs). The prices of the materials stocks and REITs have risen in anticipation of this potential future growth.
Stock markets are high because expectations for corporate earnings are high. What the market will do in the short term is, as always, speculation. The market constantly reappraises future expectations of earnings, interest rates and inflation. All of those things are difficult to predict, but right now the market is high because of expectations.
Over long periods of time, stocks still offer the best opportunity to grow wealth for most investors. Owning the stock of a company means that you own a small fraction of that company. There is no better way to build wealth than to own equity.
Stock market prices are high for a reason … there is a lot of optimism. The price an investor pays for stocks is critically important to the potential return. However, there is a good reason that prices are high. Imagine the alternative.