(July 17): This market rally is, without a doubt, driven by massive amounts of liquidity, created by major central banks of the world in an effort to limit the fallout from the Covid-19 pandemic. To many, the strong global stock market recovery from the lows in March and subsequent resilience appear disconnected from the dismal economic data and corporate earnings. After all, the price of a stock is supposed to reflect its underlying intrinsic value, which is the discounted future cashflow stream, plus a layer of premium for risks and liquidity. By this measure, many of the best-performing stocks are trading at irrational valuations.
The reality is that, while earnings and cash flow determine stock prices in the long run, short-term prices are driven by demand and supply. Investor demand is, in turn, driven by prevailing storylines.
In other words, the seemingly irrational stock prices we see today reflect the chase for the hottest trends — be it fad, hype, buzz or, yes, even blind faith — rather than staid old business models, sustainable competitive advantage, balance sheets and profit margins.
