What Is 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 markets have similar features to bull markets, although a buoyant market may not necessarily last as long. After the 2008 market crash, for example, the equity market became buoyant and hit an all-time high just seven years later.
A buoyant market is one that displays prices that gradually trend upward over time. A market that displays buoyancy or becomes buoyant normally occurs as a result of optimism regarding the economy, which generates positive economic activity. It becomes a self-fulfilling prophecy of sorts, in which people begin to regain confidence after a down market and increase investment, consumption, and savings. These factors drive the prices of commodities and equities higher. People view this as a positive sign and begin to generate more economic activity, 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 work to increase the average P/E ratios and help buoy the market, and thus 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 on a sector by sector basis. Because many sectors and industries could have declining profit margins, the average margin for the overall market may be 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 consider margins as only one part of their investment process.