Why so HIGH?

Posted: 8th May 2024 Key

As investors observe a stark contrast between faltering economies and soaring stock markets, questions are starting to arise about the factors contributing to this financial phenomenon.


The Puzzle of Surging Stock Markets Amid Economic Slowdowns

In February, it was announced that the UK had entered a technical recession at the end of 2023, following two quarters of negative GDP growth.

We aren’t alone.

Germany’s GDP also contracted over 2023 with a steep downturn in their manufacturing sector; Japan recently slipped into recession, and other major economies, like France, are dealing with fairly stagnant growth. China’s growth rate appears to remain high at 5.2% (over their 5% target), but their most recent quarter showed only 1% growth, inciting fear that the world’s second-largest economy and a key driver to global growth may also be stumbling.1.

American exceptionalism is, as ever… the exception, with the US economy bucking recessionary expectations with solid GDP growth of 2.5% over 2023, ending on an impressive 4.9% in the 4th quarter.2. However, with its major trading partners struggling and record high federal debt/GDP levels off the back of all that Covid spending, the US economic outlook is still somewhat uncertain.

Given this rather bleak economic picture, one would be forgiven for thinking that the world’s stock markets are somewhat muted, if not depressed.

But this couldn’t be further from the truth.


Defiant Markets

The Japanese stock market, in the face of a recession, recently hit new all-time highs for the first time in over 40 years. Similarly, Germany’s DAX 40 just hit an all-time high, as has Denmark’s key index, along with a plethora of other markets. The mighty S&P500, filled with US-listed multinational corporations reliant on the span of global economies, also continues to grind out new highs.3.

What’s going on? How can markets be hitting highs while the news on the ground seems to be nothing but bad?


Understanding Stocks

First and foremost, stock markets are forward-looking. The current economic picture matters to the stock market only to the extent that it affects the level of future profits its constituent companies will make and what those future profits are worth now.

At the risk of being too technical – fundamentally, a stock (when properly valued!) is worth the future cashflows it will accrue, discounted to the present.

Put more simply – two things matter for stocks: 1. Future profits and 2. The discount rate.

In terms of future profits, 2023 is in the books, so unless the economic picture is expected to continue as is, then it doesn’t really matter for stock prices. What matters is the future economic growth feeding through to growth in company profits, and the stock markets show that this is expected to be fine long term.


Interest Rates and Stock Prices

The second component, the discount to present, is a little complex—it’s a mix of a market’s perceived riskiness and the so-called ” risk-free rate” or the time value of money.

In short, it is very reliant on the prevailing interest rate set by the relevant economy’s central bank, and its predicted path has a big impact on stock prices.

Basically, high rates –> high discount -> low stock prices.

Again, similar to profits, stocks are less about current rates (which are generally high compared to recent history) and more about predicted future interest rates. All this economic gloom has prompted the belief that most central banks (usually led by the US Federal Reserve) will start cutting rates soon as post-COVID inflation has eased and economies need the boost of cheaper borrowing costs.

This prediction of lowering interest rates, perhaps very aggressively, has therefore prompted a surge in stock prices in the relevant economies.


Different Stories in Different Markets

Each market also has its own narrative. Denmark is a prime example, with its index up significantly since the start of the year due to having over 50% of the Danish stock market weighting in a single stock—Novo Nordisk 4.—whose breakthrough GLP-1 diabetes/weight loss drugs (Ozempic, Wegovvy) have been shown to be a potential blockbuster with a wide variety of use cases against many modern ailments.


Japan’s Long Slumber

For Japan, the recent stock market rally is more a story of corporate governance. Japanese stocks have long traded at a substantial discount to their Western peers. There are a few reasons for this, a key one is Japan’s fairly stagnant growth since it’s economic bubble in the 80’s and 90’s combined with worrying demographic trend towards a rapidly aging population. Another is their odd corporate governance, with management teams hoarding cash (rather than investing it in growth or returning it to shareholders) or insisting on strange cross holdings, e.g. an industrial widget manufacturer owning a portfolio of golf courses.

While the former issue is unlikely to change anytime soon, the latter has been cracked down on by the Tokyo stock exchange threatening to name and shame those businesses with poor capital management. There is great hope that putting this stored value to work will help spur growth anew – something investors are clearly waking up, pushing the market to highs not seen for more than 30 years.


The United States of AI

The US stock market has a very high concentration of large ($100bn+ market cap) and Megacap ($1tn+ market cap) technology stocks, some of which (Apple and Microsoft) are larger on their own than the entire UK stock market.

While most technology stocks are booming, the stock of the moment is Nvidia, a GPU (graphics processing Unit – think fancy computer chips) company whose product is considered the gold standard for AI computation. GPUs were initially developed for the complex computing necessary to render immersive video game graphics. GPUs (and Nvidia) also came to the fore during the crypto craze in the late 2010s and early 2020s, as they were well-tuned for solving the complex puzzles needed to mine tokens such as Bitcoin. However, it is in more recent times that GPUs have shown their true potential as the critical component necessary in data centres for the massive computing power needed to train AI models.

AI, suddenly becoming much more mainstream since the release of OpenAi’s ChatGPT, has caused businesses to scramble, either to produce their own AI product or at least incorporate AI into their business processes, both of which require a substantial investment in data centres, boosting technology spending much of which trickles through to Nvidia. After blockbuster earnings, Nvidia was up nearly 30% in February alone, an insane rise for a trillion-dollar company, now the 3rd largest listed company in the world.5.

This boost to technology stocks, along with a general uplift from the hope of near-term rate cuts from the US’s central bank (the Federal Reserve), has pushed the US market to new highs, even while the valuations of many smaller businesses in less fashionable industries are left behind.


What to Do When Markets are High

The current state of the stock market can appear puzzling, with high values in tough economic times. However, it is essential to carefully consider whether these market valuations are based on real growth or simply speculation. Remember that prudent investing involves a comprehensive analysis and thoughtful strategy. Although swift market surges can imply risks, this is not always the case. Indeed, there are nearly always pockets of opportunity to be found—the subdued prices in the UK market could signal opportunities for investment, even in less prosperous times. Ultimately, a clear understanding and a forward-looking approach are crucial in making informed investment decisions that align with your long-term financial goals.


1. Reuters – https://www.reuters.com/world/china/view-chinas-gdp-grows-52-q4-misses-market-forecast-2024-01-17/

2. BEA, US Gov – https://www.bea.gov/news/2024/gross-domestic-product-fourth-quarter-and-year-2023-second-estimate

3. Yahoo Finance, world indices – https://finance.yahoo.com/world-indices/

4. MSCI, MSCI Denmark – https://www.msci.com/documents/10199/5db4fa3f-1775-4d39-8838-e260a97d2b94

5 Yahoo Finance – https://finance.yahoo.com/quote/NVDA/

Why so HIGH?

This article is intended for information only and does not constitute advice. References to any financial indices are made on the basis of ‘fair use’ and do not imply any endorsement or association with the index or its owner.

Wise Investments Limited is authorised and regulated by the Financial Conduct Authority, FCA no. 230553. Registered in England 4970458.

Please be aware that investments can go down as well as up.


William Geffen