Pent-up savings propel company profits and stock market

Stock prices are hitting record highs on what feels like a daily basis. House prices are sizzling in Philadelphia and across the country. And while cryptocurrency prices are swinging wildly, they have gone parabolic compared with where they were a couple of years ago.

Prices for nearly all assets — property that is regarded to have value and can be turned into cold, hard cash — are on a tear.

What gives? Are we as wealthy as we think we are?

There are good reasons why asset prices are soaring. The COVID-19 pandemic is winding down and the economy is revving up. Households that not long ago were sheltering in place are traveling again, going to restaurants and ball games, and letting loose. And they have the savings to pay for it, given how shopping stalled during the pandemic and the massive government support, from stimulus checks to unemployment insurance.

With businesses selling more of almost everything, and at higher prices, profits are up. This is great for stocks, as the value of a company’s shares is ultimately determined by its earnings. The more a company makes, and the more optimistic investors are that a company will make money in the future, the greater its value, and the higher its stock price.

Stock prices are also up because interest rates are down. The Federal Reserve slashed short-term interest rates to near zero during the pandemic and has made it clear it is in no hurry to increase them. It will do so only when the economy is back to full health. The Fed has also been buying trillions of dollars in bonds to bring down long-term interest rates. It has worked. Long-term rates are up from their lows during the height of the pandemic, but remain near historic lows.

Low interest rates support all asset prices as investors have a big incentive to put their money to work. Inasmuch as they can’t earn any kind of return in a money market fund, bank certificate of deposit, or risk-free Treasury bond, they invest in stocks, housing, and other assets. Of course, this is precisely what the Fed has in mind when it slashes interest rates. It hopes investors will buy riskier assets, which in turn provides the funds that businesses need to invest and hire, and households need to purchase cars and homes.

Record-low mortgage rates have also juiced up home buying, and with so few homes for sale, house prices have taken off. Although this is happening across the country, Philadelphia is a poster child for this, with house prices surging at a double-digit pace over the last year. Lower-priced homes in the city are experiencing the most outsize price gains, rising at a pace never seen in the nearly 50 years that house prices have been consistently tracked.

Housing also received a lift from the work-from-anywhere phenomenon triggered by the pandemic. Many apartment dwellers living in the nation’s largest urban centers fled for the safety and bigger spaces of the suburbs, exurbs and smaller cities. Many bought homes and have been willing to pay much higher prices.

While the high asset prices appear to be supported by solid fundamentals, there are indications that they are getting ahead of themselves, and turning frothy.

Froth in the stock market is evident in the advent of the so-called meme stocks — stocks whose prices have been pumped up by individual investors who have collectively decided on social media to purchase the stock all at once, sending its price skyward. The stock has been chosen not necessarily because of the company’s strong growth prospects, but in most cases, just the opposite. I won’t go into more detail, but I’m sure you sense this isn’t consistent with a well-functioning stock market.

Then there is the crypto market — the market for bitcoin, ethereum, and an exploding number of other so-called currencies. Proselytizers of crypto argue that they will eventually replace currencies backed by governments, including the euro, the yen, and yes, even the U.S. dollar. This isn’t happening, at least not as the crypto market currently works, which results in wild swings in its value. Consider that just since the beginning of this year, bitcoin has doubled in value and fallen right back down again. It is tough to fathom who would keep their savings or engage in transactions in a currency so volatile. However, there are those who would speculate in it, buying the currency with the belief that they can find someone who will buy it at a price higher than they paid for it.

So, are we as wealthy as we think we are? Probably not. Frothy and speculative asset markets are vulnerable to significant price corrections if everything doesn’t stick to script. Of course, they rarely do. Not that this is necessarily a time to sell, but more to be cautious when buying.

Mark Zandi is chief economist for Moody’s Analytics.