Good news matters. It impacts stocks because there's not enough stock to go around. We're so cynical though, we don't believe it is possible. And while we are at it, bad news tends not to matter, at least a few days after it occurs. Those are two important lessons of this market which keeps hitting record highs.
First, let's understand, this is a market that is largely driven by index funds. That money comes in automatically, every day, over the transom, and billions of dollars placed in equities will move equities.
Why does it send stocks up so much? First, it's one directional. Index orders do not come in to take money out of the market. That money tends not to be traded. So, it soaks up supply quite easily. Remember, in the end, stocks are a function of supply and demand. Before the index phenomenon mutual funds and hedge funds would always be selling and buying. They still do, but the amount of index money coming in, chiefly for retirement, far outweighs the amounts that are traded. That's as it should be. If you buy index funds for your retirement you shouldn't trade them because there's the more than likely possibility that you will not be in the market on some of the more important up days where big money is made. You should not time index fund money for retirement beyond what I do which is try to place money each month into a fund and not do it all at once.
The impact of that "money in" as we call it, has been a major prop to the bull because there are very few fixed income alternatives. There was a time when it would be silly to be overweighted in equities -- another technical term that means you have more stock than bonds.
If rates on the 10-year treasury note were at 5% or 7% I could see that stocks would lose their allure. But we are nowhere near those levels.
Second reason why money in impacts stocks so positively? The stock shortage I have been talking about. There are about half the number of publicly traded companies versus when I invested for a living more than seventeen years ago. That means the money keeps funneling into fewer and fewer companies. Plus, the stocks of the companies that are going up tend to be boosted by company buybacks. There's an extraordinary amount of stock being "crunched" or retired by the major old-line companies out there. Some of it is to shrink the so-called denominator, meaning the number of shares that is divided into the earnings. That creates the price to earnings multiple that we use as an apples-to-apples way of calculating how expensive or cheap a market is.
If companies buy back a ton of stock, then when the shares are divided into the earnings you get a much lower price to earnings multiple.
Given that companies have a ton of cash on the balance sheet and they will be getting more cash under the new tax code you may have to rethink whether this market is as expensive as it seems. If companies keep retiring stock then the market's valuation will go down and the supply will shrink. That's a virtuous circle and it calls into question whether stocks are dangerous, given the trampoline impact of money coming in regularly and the decline in the price to earnings multiple. When you throw in the fact that there are far fewer companies coming public, something that would increase supply, and there are almost no companies doing secondary offerings, you can see how there simply isn't enough stock to go around.
I always find it amazing when I look up the number of shares big capitalization stocks have retired. Take two of the best companies on earth: Walmart (WMT) and 3M (MMM) . In 2014 Walmart had 3.4 billion shares outstanding. Now it has 2.99 billion. In 2014 3M had 649 million now it has 597 million. Those incredible shrinking numbers coupled with the money coming in automatically means that stocks have a natural bid "underneath" meaning that there are always going to be more buyers than sellers of the S&P 500 because of the nature of savings. Regular money in coupled with regular retirement of stock, equals higher stock prices.
Now the stock shrinkage and the indexing factors are very important props but they aren't the only thing that produces these endless new highs.
We can attribute a lot to the new tax code. For example, Caterpillar's (CAT) stock hit an all-time high this morning on a recommendation from a major brokerage house that discusses how the new depreciation rules that allow equipment buying to be far more advantageous than it used to be are going to move up CAT's earnings substantially. That's something that wasn't going to happen before the code and came as a surprise to most money managers. It wasn't calculated into the earnings estimates; it was anything but baked in. Each day we get upgrades like this. We got another today for United Technologies (UTX) that also moved the stock. New information, depreciation, lower corporate taxes, stock shortages and target increases, they are all working to boost stocks as is the weaker dollar which might be talked about when earnings season officially starts on Friday.
The cases of Caterpillar and United Technologies are truly exemplary here because we know that many money managers want exposure to simultaneous worldwide growth and companies that are levered to it. There simply aren't enough to go around, though. So there's not only a stock shortage, there is a cyclical stock supply problem: these companies are always either buying up their stock or gobbling up other companies exacerbating the shortages in their industries.
Finally there's another dynamic at work, and that dynamic is the realization that some companies are doing very well, much better than we thought, and other companies are being revalued as businesses that deserve a higher valuation simply because of what they do.
Two cases in point: Tesla (TSLA) and Nvidia (NVDA) . Last week Tesla, reported very disappointing deliveries of its Model 3, yet now finds its stock up more than 20 points from where it "blew up." That's incredible. In the old days that stock would be down 20 points. But this market is valuing Tesla like a tech stock. I understand it: when a tech company has a new chip but can't produce it in volume this year, investors will give it a pass because it will make the semis in volume next year. When Tesla can't make the model 3 this year in volume investors give it a pass betting that next year it will. I am not saying it should give Tesla a free pass. I am saying that's obviously how investors think if the stock is up not down after those miserable numbers. CEO Elon Musk inspires that level of confidence.
Nvidia is a different case. All last week I was pounding the table to buy the stock of Nvidia because I said that CEO Jensen Huang would no doubt announce some big news as the kickoff keynote to CES, the big tech festival. I said he would not come empty-handed. Incredibly, it's like no one believed me and I made it up!
Sure enough last night Huang announced two huge deals to use his revolutionary chips: Uber and Volkwagon, the biggest taxi company on earth and the second biggest auto company on earth. They will use these chips to build autonomous cars and do so within a few years' time. It was a breathtaking union but I think totally predictable given that I predicted he would wow the audience. That's how a stock that has already been a tremendous performer can go up another 8 points.
Stock shortages, index funds that own don't trade, lower valuations than you think and negative news viewed as positive or shocking news that could have been guessed at, have all combined to levitate stocks. Remember, I am not saying buy stocks because they are levitating, I am simply trying to explain what keeps driving the market higher, and it's something that's not going away. If anything, it seems to be accelerating.