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Margaret Moran
Margaret Moran
Articles (264) 

When the Government Says to Buy Stocks, People Listen

China joins the US in promoting stocks, highlighting the influence of media on equity markets

July 07, 2020

On Monday, Chinas state media told citizens that now is a good time to buy stocks, adding that it is important to foster a healthy bull market.

Following the encouragement, stock prices on the Shanghai exchange were up nearly 6% following the previous weeks 6% gain. According to GuruFocus data, the total market cap of companies listed on Chinese stock exchanges is up approximately 12% year to date.

The immediate results of the media move on markets highlights the powerful influence that the say-so of governments and other publicly trusted institutions can often have in pushing bullish sentiment.

Words have power

The idea of investing itself is already highly appealing; who wouldnt want to multiply their money? If you are feeling hesitant to invest due to the deterioration of the economy or uncertain business conditions, what better to reassure you than the government and legions of analysts bombarding the media with things along the lines of invest now, since Amazons (AMZN) stock price could see a 20% increase before the end of the year?

It is important to note that the stock market is not the same thing as the economy. The value of stocks has always depended not on what they are actually worth, but instead on what the collective investing community, also known as Mr. Market, is willing to pay for them at any given time.

This is why there are so many success stories of speculators buying stocks and waiting for a bigger fool to come around and pay more than what they did. A good example of this is the people who made money buying shares of bankrupt car rental company Hertz (HTZ). After the company declared that it would be filing for Chapter 11, some correctly guessed that the strong bullish environment for U.S. stocks would give the worthless equity security a last hurrah, buying the shares for pennies and selling sometime during its 500% rally in early June.

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According to Executive Director Amy Quackenboss of the American Bankruptcy Institute, We will likely see an increase in bankruptcies, starting with business filings in April and May, and increased consumer filings to follow The magnitude of the increase in filings will depend on how long and deep the economic crisis goes on.

Despite the real income of many companies declining and Fed economists expecting potentially up to a million bankruptcies over the next 12 months, U.S. investors are generally bullish, and there isnt any one single explanation that can account for this.

However, the waves of positive media coverage undoubtedly play a significant role. Each time the Federal Reserve has cut interest rates or announced a new round of bond buying, exchange-traded fund-buying or other liquidity injections over the past few months, U.S. stocks have rallied on the good news, despite the fact that the real effects of these measures on companies bottom lines are more long term than immediate.

Headlines on the potential of various stocks, especially large-cap tech stocks, potentially granting significant returns have also had a positive effect on peoples willingness to buy. The world is more connected than ever, with the average American consuming 11-plus hours worth of media per day according to the Nielson Total Audience Report. Add this to the fact that humans have a natural confirmation bias i.e., a tendency to more readily believe words that confirm their pre-existing biases, hopes and expectations and the effect of positive media coverage on stock prices can go a long way toward propping up prices, especially when they come from government or financial institutions.

The liquidity problem

In addition to positive media coverage, both the increasing corporate debt bubble and the rise in popularity of retail and index investing have also resulted in a higher percentage of gross domestic product being directed toward stocks. The more liquidity being directed toward stocks, the more prices will naturally rise.

As I pointed out in a previous article, U.S. corporate debt has reached $14.5 trillion as of the first quarter of 2020 compared to GDP of $21.53 trillion, meaning corporate debt has now reached approximately 67% of the countrys GDP compared to only 44% in 2008. The chart below, which shows the ratio of total market cap to GDP, indicates a correlation between corporate debt and stock prices. While this is far from the only factor contributing to overvaluation, it is certainly a component as the cash acquired from debt offerings typically goes toward share buybacks, business investments or simply increasing the companys cash on hand.

The bottom line is that the more liquidity goes toward stock markets, the more prices increase, regardless of whether this liquidity comes from debt, the Feds quantitative easing measures, government bailouts, pension funds or an increase in the number of articles saying that JPMorgan (JPM) expects the positive drivers for equity markets will likely continue.

You may have seen more than one article complaining about how inexperienced Robinhood traders are driving overvaluation in U.S. markets. There is no denying the truth of this; more retail investors means more liquidity, and while their pockets are certainly not limitless, there are certainly more of them now than there were a few decades ago.

However, that doesnt necessarily mean that liquidity will increase indefinitely. There are quite a few things that could cause the flow of money to stocks to slow down. For example, the U.S. has an aging population. The number of Americans over 65 is expected to more than double by 2040, and those that retire will begin to withdraw from their pension funds instead of adding to them every month. Given that pension funds are the biggest buyers of high-yield corporate bonds, this means that companies may find it harder to supercharge their earnings with debt.

Another danger is that if unemployment remains low, fewer retail investors will have the extra cash to invest.

Finally, with passive index funds surpassing actively managed funds as of September 2019, there are bound to be more sharp corrections in the future. Many passive funds will automatically trigger a conversion to cash if prices drop quickly enough, exacerbating the steepness of the decline.

Conclusion

The influence of positive media coverage on the prospects of the stock market is an important driver of prices that should not be ignored, whether it comes from legions of analysts or a government entity like the U.S. Federal Reserve. Government aid in particular has the potential to translate to cash bailouts and direct support through liquidity injections and quantitative easing.

On the other hand, this does not mean that the government will always come to the rescue of every company, especially if said company does not play an essential role in infrastructure like the big banks do. How much of a stocks price growth is related to its popularity? What could potentially shake that popularity? What other factors are supporting the price? Investors should be sure to keep an eye on all the moving parts.

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