Market Factors: Nine reasons the rally has powered through every obstacle

This edition starts with a terrific research report form an HSBC strategist outlining why the market rally seems unstoppable. Section two details the risk of higher borrowing costs for REITs. The diversion introduces a new AI-uncovered anti-aging drug and we have Quick Hits at the end as always.

Equities

Nine reasons for rally resilience

HSBC chief multi-asset strategist Max Kettner outlined nine reasons why the U.S. and global equity market rally has been near-bulletproof since the pandemic. Nothing – not a regional banking crisis, geopolitical conflict, or tariff wars – have been able to derail the rally for long and Mr. Kettner believes he knows why.

The first reason is earnings. Profit growth has remained strong even when economic growth flagged. Low U.S. corporate tax rates are a big contributor.

The second reason is the positive correlation between equities and bond prices. There is no diversification benefit when both are moving in the same direction and this has supported asset inflows into equities where potential upside is higher.

Reason three is the wealth effect, the tendency of stock market gains to support consumer confidence to the point they increase spending and investing. This results in revenue growth and higher stock prices.

The expanded central bank toolkit is reason four. The financial crisis and pandemic created precedent for Federal Reserve and Bank of Canada intervention at an early stage of market volatility, preventing bear markets. The Fed’s liquidity support during regional bank failures in 2023 is a good example of this trend.

Reason five is developed world oil intensity – the amount of oil required for each percentage point of economic growth. This number has declined substantially since the 1980s due to energy efficiency and alternative power sources, so higher oil prices cause less dislocation to the economy and equity markets.

Reason six, low non-government debt levels, does not apply to Canadian consumers. In the U.S. and much of the G10, however, consumer debt levels are low compared with the pre-financial crisis period. Corporate interest payments on debt relative to profits have been falling since 2010, leaving balance sheets healthy in most cases.

Reason seven relates to number six – higher corporate credit quality. New economy companies, technology notably, do not require massive loans for business expansion and thus overall credit quality has improved and is less likely to cause a hiccup in stock markets.

Reason eight is programmed trading. Automated trading causes rapid market downdrafts on bad news but also quick recoveries. This feeds an investor “buy the dip” reflex.

Reason nine is passive money inflows into stocks. There is a rising number of investors that contribute to index tracking funds without looking at recent performance (which is wise). They are not scared off by volatility. The proliferation of target date funds that provide a set return at a future date, and rebalance between fixed income and stocks, also help equity market returns by rebalancing more into stocks.

Mr. Kettner would be the first to concede that these trends do not guarantee continued high equity returns but the argument for resilience is compelling.

Real Estate

REITs and rates

A timely report from Scotiabank real estate investment trust analyst Himanshu Gupta estimated the negative effects of higher interest rates as REITs head to bond markets to refinance and pay higher yields. The exercise helped explain recent REIT performance and also uncovered potential value.

In (very) simple terms, REIT profits are the difference between total rents received and the combined cost of managing properties and the interest costs on the debt used to buy the asset. The debt, of different terms, is constantly maturing and the REIT has to borrow to repay the principle at market rates.

Bond yields are higher by roughly half of one percentage point since July and this threatens profits for REITs going to market now. Mr. Gupta looked at all of the REITs in his coverage, looking for those who have to borrow funds soon, and assessed the damage of higher interest costs to profitability.

Storagevault Canada (SVI-T) is set to roll over debt and this explains the REIT’s recent underperformance, at least in part. BSR REIT (HOM-U-T), GO REIT (GO-U-T) and Vital Infrastructure Property Trust (VITL-UN-T) face similar dilemmas and Scotiabank estimates this will reduce 2027 gross profits (funds from operations) by 2.5 per cent if rates remain higher.

Granite REIT (GRT-UN-T) and Chartwell Retirement Residences (CSH-UN-T) face a different problem. They have underperformed despite minimal exposure to interest rates, according to Mr. Gupta. This suggests a potential buying opportunity, all else being equal.

Diversions

AI develops anti-aging drug

A company named Insilico Medicine used AI to develop a drug that appears to have marginally reduced aging in a small sample of test subjects. I have thoughts.

Researchers have developed tests that measure mortality through biological markers and psychological assessments that provide a quantitative proxy for age. Insilico’s drug rentosertib, initially targeted at chronic lung disease, was also seen to improve some of the age-related biomarkers.

This could all be nothing. This time. But it is an example of the potential use cases for AI that have wide-ranging humanitarian benefits. Like CRSPR, the technology is so potentially useful that related dangers will likely be ignored. This assumes that successful drugs will be discovered by AI, I get that.

The news also reminds me of my favourite comedian bit of the past five years, from Canadian standup Pat Burtscher. He starts with “Does anyone else thinks it’s crazy they keep finding out ways to make life longer?” When considering the possibility of living until 150 he says: “Who the f—k asked for that?” and “They keep adding to the worst part – the end.” The full bit is here on Youtube. Do I really have to warn you there’s adult language?

The essentials

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Globe Investor highlights

Ahead of U.S. midterm elections, the options market is showing a potentially toxic mix of fragility and fearlessness

Want to invest like David Rosenberg? A new ETF lets you do just that

Stocks with ties to the Canada Investment Summit that are seeing insider buying

The Globe’s Andrew Galbraith on the “well-behaved” Canadian bond market despite the sell-off in U.S. Treasuries

Dr. George Athanassakos argues the U.S. Treasury Secretary’s revisit of “Operation Twist” in the bond market will be a failure

After huge gains for Canadian bank stocks, money managers look south of the border for better returns

Quick hits

CNBC personality Michael Santoli identified the iShares Nasdaq Top 30 Stocks ETF (QTOP-Q) as a key portfolio for investors to follow as a broader market indicator. The ETF includes the Magnificent Seven stocks in addition to major semiconductors and industrial stocks with high AI exposure. The ETF peaked in June, sold off in the subsequent volatility, and has since recovered some but not all of the ground it ceded. Mr. Santoli thinks it has to start hitting new highs or we’re in for more tech volatility.

My bearish newsletter last week got a lot on website traffic which, of course, means that investors have less to worry about if this is a telling sample. Rallies rarely if ever end when everybody’s afraid of a downdraft.

Wells Fargo analyst Shahriar Pourreza (they call everyone an analyst, Mr. Pourreza seems more of a policy expert) notes that local moratoriums on data centres in the U.S. have reached 530 as opposition surges. Mr. Pourreza believes resistance will fade after the U.S. midterm elections and that opposition at the state levels is surmountable for major projects.

Read this week’s earnings and economic calendar here