This article was first published in the National Post on July 18, 2020. It is being republished with permission.

by Tom Bradley

There’s one investment question that’s being talked about almost as much as the weather. It goes something like this: “Why does the stock market keep going up? The economy is a mess.”

Why indeed? The path out of this recession is anything but clear. It’s hard to know when the economy will fully open up, how families and governments will deal with the increased debt load, and how profitable companies will be when running at less than full capacity.

In our household, when something doesn’t make sense, my wife invariably asks, “What is going on?” It’s code for, “There must be a reason, so let’s figure it out.” In the case of the stock market, though, there is never just one reason. Here are a few.

The declines were overdone. The panic during the dark days of March was the worst I’ve seen in my 37 years in the investment business. The urgency to sell caused violent price declines, and resulted in the quickest bear market in history. It’s important to note that gauging the rally from this moment of maximum panic exaggerates the rebound. Year to date, most markets are still down.

The recovery has also been uneven. Stock markets, particularly in the United States, are being carried higher by a narrow group of stocks. These mostly tech-based companies did well during the lockdown and are expected to benefit further from a world that will never be the same. But while their prospects may have improved, it’s been their expanding valuations that have enabled them to carry such a heavy load in the market.

Meanwhile, the rest of the market has been left far behind. Companies that were hit harder by the lockdown, and have an undefined recovery, are languishing well below their previous highs. The pervasive view that “things will never be the same” is having the opposite effect on these stocks.

Rates, rates, rates. Everyone is talking about what the post-COVID economy will look like, but not enough fuss is being made about lower interest rates. Rates have declined from what I’ve dubbed recessionary levels to depressionary levels. A Government of Canada 10-year bond now yields 0.55%.

With the drop has come a stronger consensus that rates will stay near zero for an extended time. This lower-for-longer scenario impacts stocks in two ways.

First, lower interest rates make fixed-income securities less attractive. A savings product from the bank, or a low-risk bond, doesn’t earn enough to offset inflation. This causes money to migrate up the risk curve, creating more demand for stocks.

Second, lower rates make stocks worth more, since a company’s value is derived from its future stream of profits and dividends, which then needs to be converted into current dollars using a discounted cash flow calculation. A key variable in this formula is the investor’s required rate of return, or discount rate, which is based on the expected level of interest rates and is adjusted higher to compensate for the inherent uncertainty in forecasting long-term earnings.

Why does this matter? Well, a company’s intrinsic value is very sensitive to the discount rate. A stock’s potential upside significantly increases when analysts reduce their discount rate, as some are doing now.

Ultimately, we don’t know for sure what’s driving the stock market higher. It’s impossible to determine how much of the move is based on fundamentals, such as long-term profits or lower interest rates, and how much is from a less sustainable source, namely emotion-driven momentum (i.e., the fear of missing out).

The mysterious market rally won’t be the last surprise we’ll have during this recovery. The COVID-19 crisis is likely to be different than most cycles that follow a predictable path guided by the laws of supply and demand. In this case, the range of possible economic and market outcomes is very wide.

It seems perverse, but when there’s so much ambiguity, investors desperately want to do something, and are therefore inclined to act more boldly than usual. But now is not a time to get locked in on one view of the world. Investing isn’t about precisely predicting the future, but rather building a portfolio that’s suitable for a variety of outcomes.