What’s driving equity markets?

Four significant factors are driving global equity markets now and shaping our thinking about where to invest.

By far the biggest driver is global money supply as central banks around the world have poured money into economies hard hit by the Coronavirus (COVID-19). This has been supported by the fiscal response as countries have undertaken large fiscal measures to provide support for the corporate sector and households. In the United States (US), President Joe Biden signed a $1.9 trillion COVID-19 relief package in March.

Although the pace at which central banks supply money is expected to reduce, we will still see balance sheet expansion for some time.

This massive supply of money has led some economists to warn of rising inflation levels. If we see stubbornly high inflation levels, central banks would be forced to raise interest rates. But this is not our base case and we don’t expect a dramatic rise in inflation in the coming months.

The other three factors driving global equity markets are economic growth, valuation and sentiment.

As you can see in the graph below, growth in money supply has far more of an impact on equity prices than economic growth does. The green line indicates combined balance sheets for four major global central banks: the US, Bank of England, Japan and European. The red line shows the FTSE All World Index, an international equity index, which tracks stocks from developed and emerging markets worldwide. The two have moved more in less in tandem since 2008.

Money supply

Money supply

Source: Ashburton Investments

As countries recover from the effects of the pandemic, we will start to see economic growth, which should lead to recoveries in the earnings growth of companies. This recovery will, however, be asynchronous due to the uneven vaccine rollout across the world.

The third driver of equity markets is valuations with markets reaching all-time highs. But we must caution that some of best returns come at the end of bull markets.

The fourth driver is sentiment. There are many people with excess savings as a result of fiscal stimulus packages – and they are turning to investing leading to a large increase in retail participation in the market.

Driven by greed and fear, some people are looking at rather frothy investments, such as tech companies that have never made money or generated cash flows, which we avoid.

In light of these drivers of global equity markets, we continue to focus on quality companies with growth at a reasonable price. We look for strong balance sheets, growing intrinsic value and relatively high cash conversions. We take note of whether the companies treat shareholders well over time, the sustainability of their business model and steady and growing earnings.