While the Nasdaq is making new highs, and plenty of other markets are getting back close to previous levels, markets remain concerned about seconds waves, further lockdowns and, of course, the sheer scale of economic contractions being experienced. The market may be climbing a wall of worry and these concerns may ease over time. Alternatively, markets are juiced by excess liquidity and must reset eventually. 
The bullish case rests on the idea that it is easy to construct a valuation case with interest rates so low. A solidly growing, non-capital intensive, business can look very cheap if bond yields are to remain as low as they are. Many traditional models based on cash flow, growth and a discount rate can be made to give exceptionally high valuations in the current circumstances. Essentially, if the required return is only 4 per cent, 1 per cent risk-free plus 3 per cent risk premium, even the dullest company can appear cheap on 25x earnings, especially when nominal GDP alone might lead to growth close to 4 per cent. Basically, quantitative easing has made all traditional valuation methods irrelevant and TINA (‘there is no alternative’) applies.
An example of this world in practice, can be seen from Siemens Healthineers recent acquisition of Varian, a US competitor. The $16.4bn deal can be financed with debt costing 1 per cent in euros, making its earnings enhancing even at 50x. A few years ago, this would have seemed absurd. In the world of central bank intervention, to set interest rates and manipulate credit spreads, all previous realities are suspended. Strong businesses with access to capital markets can expand unconstrained by the old rules of corporate finance. No doubt there will be more deals like this.
These economics go a long way to explain why large-cap growth stocks are driving the market higher. These are the businesses with effectively unlimited access to cheap capital to fund further growth. Smaller businesses are reliant on a struggling bank sector for access to much more expensive capital, and therefore at the huge disadvantage. We don’t have space to explain here how that would have negative effects on long-term economic success in the long term. The short term, however, is clear.
Looking at the negatives, there are three main ones. Firstly, and easiest to refute is the concern that central banks can’t keep a lid on interest rates, and now credit spreads, forever. The answer to that is that it is entirely within their gift to do so. With now unlimited balance sheet capacity and a 10-year history of direct market intervention it is difficult to imagine that policymakers would tolerate the consequences of markets setting interest rates. The reset would be extremely painful.
The next concern is more real, a potential second wave and further lockdown. No-one can really predict whether we will see a second wave, but various governments are coming out to suggest further lockdown measures are less likely. What is clear now, however, is that the market is being driven higher primarily by companies that are largely immune to these measures. The most hard-hit sectors may have recouped some of their losses, but they have failed to keep up. These areas, such as travel and high street retail, remain a relatively small part of the market.
The final worry is whether the huge level of economic damage must at some point impact on all areas. Here we are perhaps in uncharted territory, as the level of contraction is currently being masked by enhanced benefits and furlough schemes. We cannot know what the consequences are for this unprecedented stimulus, nor can we know to what extent the economy will rapidly recover.
Our approach as ever is to avoid the imponderables and stick with the easier decisions. There are some clear winners from current events, those companies with strong and growing business models. This is particularly so in areas which comprise our favoured themes, the digital economy, new energy and robotics. We are able to avoid answering the difficult question of the type and rapidity of any economic recovery by focussing on these businesses, while as pragmatists we can certainly adapt as the current environment changes.
David Jane is a multi-asset fund manager at Premier Miton Investors. The views expressed above are his own and should not be taken as investment advice.