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AT THE CRACK OF DAWN each day, I grab a cup of coffee, and then dig into the latest investment articles and research reports. Last week’s most intriguing insight: According to data from Emerging Portfolio Fund Research, investment flows into global stocks are on pace to hit $1.048 trillion this year.
To appreciate the magnitude of this year’s inflows, consider that 2017 ranks as the next strongest year—at a relatively paltry $300 billion. Other years, such as 2008, 2016 and 2019, featured significant outflows. But in 2021, it’s all aboard the stock market train.
In fact, investors have been pouring so much cash into the stock market that this year’s total could eclipse cumulative flows for the prior 20 years. Given this buying frenzy, it’s not surprising that stocks are up strongly in 2021, with Vanguard Total World Stock ETF (symbol: VT) gaining more than 15% through last Friday.
What’s driving the massive flood of money into stocks? The extra liquidity supplied by the Federal Reserve and other central banks has obviously helped, as has the bevy of government stimulus and recovery packages. These aggressive monetary and fiscal policies have no doubt also fueled run-ups in things like cryptocurrencies, nonfungible tokens and collectibles.
To be sure, corporate profits have rebounded impressively from last year’s depressed levels, helping to justify the stock market run-up. Moreover, not all sectors have benefited, which suggests the buying hasn’t been indiscriminate. Niches like gold and emerging market stocks haven’t gotten much love this year. Long-term Treasurys and global corporate bonds are also laggards. Despite investors’ huge 2021 appetite, it seems diversification is still a worthwhile strategy.
I know it’s a fact, but I still see it a conundrum. Why do corporate earnings drive stock prices? If a company reports higher earnings, it’s stock typically rises, but what does that really mean to an investor? Why pay more for a stock just because earnings rise…because someone else will pay more the next day? It make sense if those higher earnings are proportionally shared with shareholders, otherwise it seems more value is created out of nothing.
Higher earnings should lead companies to take a course of action which directionally will benefit shareholders even more in the future: 1) higher dividends as you indicate, 2) stock buybacks, 3) capital investment to generate even more profits, 4) debt retirement which further increases earnings, 5) buying another company to further bolster profits, or 6) sitting on cash to bolster the balance sheet until one of the item 1-5 alternatives is taken.
Bolstering profits seems a circular argument. It still means nothing to me as the investor unless it’s used for 1 or 2 and yet most money is made – or lost on the speculative relationship between earnings and stock price. I’m not sure investors invest hoping for 1-2 rather than what I’ll call gambling for lack of a better explanation.
Richard, would you rather buy a stock in which earnings per share are increasing (and expected to continue increasing), or decreasing (and expected to continue decreasing or stay flat)? Unless you believe that stock prices are totally random, and that company values based thereon are random, you must assign some significance to rising earnings per share, right?