Why Are Stock Markets So Resilient These Days?

And can it stay that way?

It’s been a while since I’ve written about the stock market, mainly because there hasn’t been much to write about. Over the past decade, stock markets (especially U.S.) have shown an impressive ability to shrug off economic worries and chug along. The resilience of markets in itself is actually quite interesting, so that’s what we’re going to discuss today.

From a financier’s perspective, stock market valuations reflect the expected future growth rate of corporate earnings and investors’ confidence that those expectations will be realized. All other things equal, the higher the expected growth rate, the higher the valuation. And the more confident investors’ are the higher the valuation (another way to think about this is that the more uncertain investors feel about companies’ prospects, the lower the valuation will be).

But these days that’s not all there is to it. There’s been a persistent froth to markets that can’t be explained by just expected earnings growth and confidence, unless you’re willing to entertain irrationally exuberant levels of earnings growth and confidence or say basically there’s no chance of a recession in the coming months.

For the longest time, I assumed that rising interest rates would finally kill this bull market. Fed (Federal Reserve) largesse had been the main driver of the post 2008 bull market. Thus, it seemed obvious that when the Fed finally tightened monetary policy, it would end the bull market. That looked to be the case last year.

But the selloff was muted — the S&P 500 declined just 25% peak to trough and barely stayed at those trough levels. The S&P 500’s 2022 low (reached in October) was still 6% higher than its 2019 post COVID peak. Since then stocks, especially tech stocks, have rallied hard. All of a sudden you stopped hearing about recession fears and inflation fears. Investors stopped fretting over how rising rates might impact the uncertain and tiny earnings of loss-making tech stocks. The bull market was back! But why does the bull keep coming back and will it continue to stick around?

Why is the stock market so resilient?

In my opinion, the U.S. stock market’s resilience is due to the following:

1. The economy seems more robust to shocks than in previous decades thanks to the many actual stresses that have been forced upon it over time. Inflation brought with it nearly a decade of stagnation in the 1970s, this time it looks like decisive interest rate policy has allowed us to address the issue in a year. The pandemic shut the economy down for several months and forced supply chains to twist and restructure in real time, yet companies adapted to the changed landscape and thanks to the willingness of the government to follow the 2008 playbook (money printing), the U.S. came out the other side smelling like roses. Bank failures nearly destroyed our financial system in 2008 — yet no one batted an eye this time when SVB and Credit Suisse went down because banks had strengthened their balance sheets and policy makers already had a playbook in hand. Thanks to both the adaptations to and experiences of historical stress events, the economy is now more robust.
2. Policy makers are smarter and more experienced than they used to be. We learn from those that came before us and their successes and mistakes — policy makers are no different. Ben Bernanke studied the mistakes made by central bankers during the Great Depression and was able to successfully navigate the Great Financial Crisis. Jerome Powell and the current batch of bankers have studied the 1970s along with other inflationary shocks and are using the knowledge and experience gained during those times to make better and more decisive decisions now to control inflation.
3. American companies are more consolidated and bigger than ever before. There’s good and bad aspects to this of course, especially from a societal perspective. But from an economic perspective, bigger companies’ stronger balance sheets allow them to weather economic storms that smaller companies can’t (which means fewer bankruptcies and credit crunches). And since more and more people are working for these bigger companies, they’re less likely to be let go during a mild recession (which helps protect consumer spending during downturns). Bigger companies also have more pricing power to protect their margins and the ability to spend excess cashflow as well as newly borrowed money on expanding their operations even during recessions.
4. We’ve been extremely fortunate with the timing of each next bubble. Prior to COVID there was the crypto and blockchain bubble as well as the gig economy bubble — these created a lot of hype and investment that both created real companies (like Coinbase, Uber, and Airbnb) and increased the bullishness and enthusiasm for stocks in general. Then after COVID, there was the work from home bubble that got folks excited over the stocks of companies like Zoom, Peloton, and DoorDash. In the middle of all that, we also had the meme stock bubble (along with peripheral bubbles in sports cards, NFTs, and Rolexes). Then suddenly in 2022 it looked like all the bubbles were either popping or popped with nothing on the horizon to drive investor excitement and hype. Just when all seemed lost, enter ChatGPT and AI — impeccable timing.
5. China basically tripped itself economically. China was way too draconian both in terms of popping its real estate bubble as well as shutting down its economy to control COVID. This has significantly slowed its economy. At the same time, its recent war-mongering and vilification of the West has made it a much less attractive investment destination versus just a few years ago. All that capital has to go somewhere and a lot of that capital has probably ended up in American assets, especially stocks.

So is market resilience here to stay? Three of the drivers seem structural and should be around for at least the next decade or so. Two of them (the great timing of the bubbles and China’s trip) are due to chance. However, it takes a long time for an economy like China to turn around, especially given that many previously positive feedback loops in its economy have now turned negative. The AI bubble seems to also have legs in terms of infrastructure and application (though the big question is whether the long-term impacts of AI will be a net positive for the economy or not).

So for now, it looks like market resilience is here to stay.

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