Why the stock market is going higher

Another huge week for the stock market. The S&P 500 is now at 2660, a gain of 40 points from my earlier update and a YTD return of now 6.5% in just 18 days and a 12.5% return off the lows.

Although the market is still 10% off the highs in September 2018, I am as optimistic as I can possibly be that it will go much higher, for the following reasons and more:

1. The economic fundamentals are strong. There’s tons of consumer spending, low unemployment, tons of exports, tons of innovation in Silicon Valley, and corporate earnings still growing at 10% a year. Despite the sell-off in 2018, no hint of any recession.

With the exception of a small decline in 2008, consumer spending shows no signs of slowing:

source: tradingeconomics.com

2. Tariffs are a non-issue and having the opposite effect as predicted they would: inflation is low and trade with China has actually increased.

3. Any domestic weakness in consumer spending is offset by booming foreign consumption, especially by the wealthy Chinese and wealthy Americans.

Wealthy consumers are playing an increasingly large role in consumer spending, which is why Wall St. is not too concerned about stagnant real wages for most Americans. Maybe it’s unjustifiable, or unsettling how so few people have so much power and influence over the economy, but that is just how it is. Jordan Peterson talks about how for developed societies, the distribution of wealth, resources and influence follows a Pareto distribution.

4. Looming pension crisis. This a major and overlooked contributor to higher stock prices for the foreseeable future. To meet obligations, funds have to invest more aggressively in stocks because bond returns are poor and liabilities are rising. Meeting a 7-8% return objective in a 2-3% yielding bond market necessitates a higher stock allocation:

One reason why public pensions remain so willing to bet on stocks is because of persistent funding problems at many systems that don’t have enough assets to cover all future liabilities. Pensions rely partially on investment income to meet future obligations to workers and retirees; many depend on large allocations of stocks to meet their aggressive return targets of 7% to 8% a year.

5. Passive investing. Professionals in tech and other sectors who make a lot of money need somewhere to park it, such as index funds. All over Reddit, there are many people diligently investing their discretionary income in index funds rather than wasting it on consumption.

6. Sovereign wealth funds. The Saudis earn billions of dollars a year in oil profits. A reason why presidents such as Trump and Bush are close to the Saudis even though people complain about it, is because the Saudis are a major investor in U.S. assets, such as stocks, businesses, tech start-ups, and so on.

7. Expanding multiples. The PE ratio of the S&P 500 is still only 20 despite a nearly 300% rally from the 2009 lows. The market is not even in a bubble stage. Due to aforementioned factors, it’s possible the PE ratio of the S&P 500 may peak at 30-35, which may herald the end of the post-2009 bull market. A PE ratio of 35 means a minimum value of 4600 for the S&P 500. But if earnings rise 11% a year (a conservative estimate; the historic median growth rate is 12.3%) and prices rise 15% a year, solving this equation (1.15/1.11)^n=32/20 [the 32 in the numerator is the expected PE ratio and 20 is the current] shows the bull market has 13.3 more years for a total return of 1.15^13.3, or 540%, giving a final value of 17,000 for the S&P 500 with a PE ratio of 32. If that seems implausibly high, from January 1986 to January 1999 (13 years) the S&P 500 went from 200 to 1200, a gain of 500% with a PE ratio of 30 or so by 1999,and that includes the crash of 1987.