How do you measure stock market mania? One way is to count the shattered records. In Toronto this week, the S&P/TSX Composite climbed to its highest level ever. So did its American cousins. The S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite all surged to fresh peaks.
Investors are taking any flicker of good news – any flicker at all – as reason to break out the champagne and start celebrating. Case in point: Avis Budget Group Inc. Its stock price more than doubled on Tuesday after the car-rental company announced better-than-expected earnings for the past three months and said it was in talks to add electric vehicles to its fleet.
No doubt plug-in cars are a wonderful thing. Still, it is difficult to see what investors are thinking. Radically revaluing a business on the basis of a solid quarter and some shiny new e-buggies appears to be – choose your word here – overdone? Rash? Downright lunatic?
One way to understand the general euphoria is to acknowledge that stocks have no real competition, at least for investors who seek short-term profits. Bond yields are dismally low and look appealing only to those who see calamity lurking around the corner.
But even Eeyores have to gulp before buying bonds at current yields. Consider the benchmark 10-year U.S. Treasury inflation-protected bond, which pays a real return that is calculated after accounting for the corrosive effect of inflation. At its current real yield well below zero, it is guaranteed to erode your purchasing power by more than 1 per cent a year.
The problem with the latter theory is that markets are not feeling jittery at all. The week started with a flurry of concern about the possibility of central banks rushing to hike interest rates faster than expected to stay ahead of inflation, but those fears subsided after the Bank of England confounded expectations and stood pat on Thursday. The week ended on a high note with reports that Pfizer had developed a new antiviral pill that may radically reduce hospitalizations from COVID-19, as well as strong jobs reports in the United States and Canada.
Investors seem to be counting on even more good news to come. A good way to track the state of the market’s nerves is to look at high-yield bonds issued by companies with less-than-stellar balance sheets. The yields on these risky investments should go up the moment the economy starts looking dicey as bondholders hurry to demand bigger payoffs to compensate for growing risks of default. As worries grow, the spread between the yields on high-yield bonds and the yields on safe government bonds should expand.
This is exactly what has happened in the past. The spread has widened before recessions and also before tense moments such as the euro zone crisis of 2011-12.
Right now, though, high-yield credit spreads are at some of their lowest points in the past two decades. Markets are not worried at all. They seem convinced that central banks and policy makers have their backs.
It is tough to argue, given all the recent evidence. But wise investors may want to keep a close eye on the credit-spread indicator. It can change quickly. And after markets’ recent record run, some worry seems justified.
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