DEFINITION of 'Buoyant'
Buoyant is a term used to describe a commodities or equity market where the prices are generally rising and when there are considerable signals of strength. These types of markets can be very volatile as prices usually rise after a period of economic instability and uncertainty. After the 2008 market crash, for example, the equity market became buoyant and hit an all-time high just seven years later.
BREAKING DOWN 'Buoyant'
A buoyant market is one that displays prices that are gradually trending upward over time. A market that displays buoyancy or becomes buoyant normally occurs due to optimism regarding the economy, which generates positive economic activity. It becomes a self-fulfilling prophecy of sorts, where people begin to regain confidence after a down market and increase investment, consumption and savings, driving the prices of commodities and equities higher. People view this as a positive sign and begin to generate more economic activities, further increasing prices.
Buoyant markets usually display characteristics of high corporate profits, low cost of capital and a high return on capital. Markets that are considered to be buoyant have strong underlying performance, specifically higher than average corporate price-to-earnings ratios (P/E ratio) and profit margins.
Price-to-Earnings Ratios in a Buoyant Market
When an equity market displays an average P/E ratio that is high, it is normally due to the fact that corporate earnings are forecast to grow, the cost of capital is expected to decline and the returns on capital are assumed to increase in the near-term. Additionally, the more corporate profits that are earned the higher the average cash-on-hand of public companies, increasing P/E ratios.
All of these underlying factors that work to increase the average P/E ratios help buoy the market and increase prices. However, inflated P/E ratios may signal that the market is overvalued, and investors should be objective in their assessment. An investor who enters the market at the beginning of a buoyant period is set to profit, while an investor who takes a long position at the end of a buoyant market may realize losses.
Margins in a Buoyant Market
If a buoyant market is one with increasing prices, it makes sense that a market that displays buoyancy will have higher corporate profits, and therefore, higher profit margins. Increased profit margins will lead to more cash on hand, which will increase average P/E ratios and further signal a buoyant market.
However, the profit margins should be looked at sector by sector, since often, many sectors and industries have declining profit margins and are held up by a few sectors with massive growth in margins. This makes it look like the average margins in the market are increasing. Investors should only invest in sectors that display confidence.