The Real Reason Why Equities Will Keep Rallying

NYSE traders
Adam Jeffery | CNBC

A market pause? Or the start of a bigger downturn? That's the question most investors are asking themselves after global equities dropped around 5 percent over the past two weeks on worries the Federal Reserve might curtail its quantitative easing (QE) program this year.

The views have so divided investors that even two men who share the moniker of Dr. Doom couldn't agree on the way forward.

Nouriel Roubini, the bearish economist who called the financial crash of 2008 now says stock markets will rise for the next two years and that worries about the Fed tapering quantitative easing were premature.

(Watch: Full Roubini video)

But Marc Faber, also known as Dr. Doom, says although further stock market gains were likely, those gains should not be trusted by investors.

(Watch: Full Faber video)

"I think the market is actually quite vulnerable. I think the market is rolling over," he said, pointing to the sharp drop in some international markets in recent weeks.

"If someone put a gun on my head and said 'you have to be long or short,' I would take the short side."

But that hasn't scared off U.S. investors from continuing to pile into equities. For the first five months of this year, a total of $74 billion flowed into equity mutual funds, according to data from the Investment Company Institute.

One reason has been the relatively low rate of return on other asset classes. Real rates (returns after subtracting for inflation) are still negative for most bonds given the zero or near-zero interest rates and the huge bond buying programs unveiled by major central banks in recent years.

(Read More: Market Pullback Could Finally Be at Hand)

That phenomenon known as "financial repression" punishes savers, while easing the burden of under-water debtors. It has also led to near record corporate debt issuance.

Companies around the world issued $1.2 trillion in bonds in the first four months of this year, the second-highest issuance on record in the January to April period.

"I still think there's significant cash out there, the opportunity cost of doing anything is very low. We've had strong liquidity expansion from policy, which is forcing people into these higher yielding, higher carry type strategies. And that money is still not fully invested," Tim Harris, chief investment officer at Lloyds TSB Private Bank told CNBC on Thursday in London.

Major benchmarks across the world are up around 25 percent over the past year. Even in Europe, which has suffered its longest-ever recession, with no signs of a turnaround, markets have enjoyed a strong rally since late last year.

"From April 2009, this in Europe is the second-longest bull market we've had - four years, two months till the end of May - since the 1980s," Harris said. "This setback, the 5-6 percent we've seen in the last couple of weeks, is really the first setback we've seen since October-November last year."

(Read More: Why Markets May Be Over-Reacting to Fed Tapering)

One sign that investors are expecting more gyrations in stock markets is that the CBOE's Volatility Index (VIX) has risen to the highest in more than 6 weeks, though it is still below 2013's high hit in February.

"Every time you look at periods of persistently negative interest rates on risk free assets, you have a very, very wild ride on things that give you an escape hatch," Nick Carn, founder of Carn Macro Advisors told CNBC.

But, he added, that for now equities were acting like gold last year, a place for investors to enjoy the momentum up and avoid negative returns in bonds.

"Here's an asset that you can own which gets you out of this horrible world of negative after-tax real returns and allows you to meet your retirement objectives," he said. "[This] of course is only true when it goes up. When it goes down, then you find it's rather worse than living with real negative returns."