Wall Street is an interesting place. Despite all the doom and gloom going on right now, the S&P 500 is up 16% quarter-to-date, and 34% since the recent March 23 bottom (even including today’s decline):
Are people out of their minds!? Don’t they see what’s going on right now!?
Yes. And maybe it’s not as crazy at it seems.
But first, to be very clear, let’s go around-the-world-in-30-seconds and review how we got here:
The worst pandemic in 100 years infects some 7.4 million people (and growing) globally:
Though the US only makes up some 5% of the world’s population, we somehow end up with ~28% of the world’s cases:
To blunt the damage, federal and state governments impose shutdowns/lockdowns/stay-at-home orders and we voluntarily shutter the economy:
Partially because folks are scared, and partially because stores are closed, people stop spending:
Causing 1st Quarter GDP to decline 4.8%:
With GDP now expected to be off by 50%+ (!!!) in the 2nd Quarter:
Congress encourages folks to file for unemployment, which they do, smashing all previous unemployment records:
To further blunt the damage, Congress instructs Treasury to inject $2 Trillion into the economy:
The only problem is, Congress doesn’t have that $2 Trillion lying around, so they borrow it like they never have before:
The Federal Reserve also steps up and injects a separate $3 Trillion into the financial system and capital markets:
Shortly after opening the economy back up, riots and looting erupt in response to the death of George Floyd, further damaging already-weak retail spending and rattling consumer confidence even more:
So, with that as a backdrop, where are we at today?
This week, the National Bureau of Economic Research, the official arbiter of our nation’s expansions and contractions, formally declared that the economy peaked in February 2020 and has been contracting since, ending the longest economic expansion on record at 128 months.
Also this week, June 10, 2020, the NASDAQ set an all-time record high:
You’ve got to be kidding me. How? Why?
I don’t have a singular answer. There’s a lot going on here:
Perhaps we overshot to the downside. You’ll recall there were some dark days back in March when some 2 million deaths were being estimated in a worst-case-scenario.
Today, we’re sitting at ~111,000. That’s still a lot, but that’s 90-something-percent short of some initial doomsday guesstimates. In other words, now that we have some time under our belts, we’re finding this will be bad, but not as bad as initially thought (if there is such a thing). To put this in comparison:
That’s worldwide; let’s narrow in on the US. Since January 1, we’ve lost 111,000 US citizens to COVID-19. Over that same time frame, we’ve also lost about 510,000 people to heart disease and cancer. One of those dominates the news because its new and novel; the other doesn’t get any airtime because it’s old and boring.
“Yeah, but heart disease and cancer aren’t contagious! COVID is!” Correct. But we’re still averaging less deaths-per-day than the other common contagions such as influenza, pneumonia, bronchitis, diarrheal disease, tuberculosis, and HIV/AIDS. (See red vs purple above).
Back in March, when the market was in full-on meltdown mode, I laid out a case for 2 curves:
- That peak daily new cases was a critical (good news) turning point:
- And that markets tend to turn before peak bad news:
Here we are two months later, and here’s how the data is playing out:
The solid blue line is a moving average of the S&P 500 over the last couple months. The orange line is a moving average of daily new cases over the last couple months. What was once theory is turning into observable data. Market history is repeating itself. Again.
Furthermore, both Congress and the Federal Reserve have made it abundantly clear they will spare no expense (literally) to keep the economy afloat. This will have some long-term ramifications when it comes to long-term interest rates and tax rates, but for now, there is plenty of cash and liquidity in the system.
All this cash is being used to backstop industries, individuals, and companies. Bailout used to have a dirty connotation to it. Now it’s a go-to tool in the federal arsenal. Everyone at risk of failing gets a bailout. Because this reduces risk to investors, this technique has become known as the ‘Golden Put’ – the fact that the federal government will safety-net everyone and every asset. They have become the buyer of last resort. They will buy when no one else will. This buoys asset prices.
The shutdowns/lockdowns have hurt some companies, but helped others. Hotels, airlines, cruise ships, restaurants, and brick-and-mortar retail were hammered. But online shopping, communications, IT, and the other cadre of work-from-home essentials fared much differently. Zoom Communications, one of the leading web-conferencing systems who saw demand for their services skyrocket by almost 3,000% during the last 3 months, is now worth more than the top seven airlines combined:
Though most local small businesses were effectively put out of business for a bit, very large businesses such as Costco, Home Depot, and WalMart could stay open. With consumers holed up at home, many of whom had just received several thousand dollars of stimulus checks burning holes in their pockets, there were really only a handful of places those dollars could be spent. In fact, if we look at the top 10 companies by market capitalization, not many of them had to endure much of a shutdown:
- Berkshire Hathaway
- Johnson & Johnson
- JP Morgan Chase
Those companies had a much different April and May than did the mom & pop down the street from you. Maybe NASDAQ is setting record highs because the companies in that index were/are positioned well to endure a #socialdistancing, #workfromhome type of event. Had this been a major cyber-virus instead of a physical virus, we probably would’ve seen the opposite result: local brick-and-mortar, face-to-face would be thriving and anything internet-related shunned. The tech-crash of 1999/2000 should be a gentle historical reminder of this.
Which brings me to a final point. Equity markets may be up largely because in the face of lots of bad news, it’s hard to find any other attractive alternative. When it comes to investing, there are 4 major food groups:
Looking at the current status of each in reverse order:
Currencies: cash is cash. Though essential for daily spending, it doesn’t appreciate much over long periods of time. Great in the short-term, a horrible investment in the long-run:
Commodities: Occasionally they spike, but here’s how a general basket of commodities – oil, gasoline, silver, gold, wheat, sugar, corn, etc – has done over the last 15 years:
Bonds: There was a time when US Government Bonds paid 5%+:
Those days are likely gone for a long while. The Federal Reserve met yesterday and essentially indicated they don’t plan on raising rates anytime soon – as in maybe 2021 at the soonest. Maybe. This is great news if you’re trying to borrow money, horrible news if you’re trying to earn interest on saved money.
Corporate bonds are currently paying a couple percentage points higher than governments, but still nothing to write home about.
Stocks: Always a roller-coaster ride, but with current yield somewhere around ~1.70% (100 basis points higher than government bonds) with at least some expectation of future growth:
You don’t make it into the S&P 500 by having a poorly run company. These companies are the best of the best. They are well managed and well capitalized. Right now, if you had to put cash to work between stocks, bonds, commodities, and currencies, which has the best long-term outlook?
Don’t get me wrong – we’re certainly not out of the woods yet. We’ve damaged the economy like we never have before:
Bruised and broken bones take time to heal. And although the stock market is showing a V-shaped recovery, it doesn’t take much to turn a ‘V’ into a ‘W’ – a double-dip.
Have markets gotten ahead of themselves? I don’t know. Valuations do seem a bit stretched. But it doesn’t matter what I think. Markets capture the current collective thinking of all investors globally. The latest market price represents the halfway point between the optimists and the pessimists. Half the market is looking at all this current data and thinking “I’ve never seen such an uncertain outlook… I think I’ll wait until it’s safe again!” The other half looks at the same data and says, “Are you kidding me? This is one of those once-in-a-decade buying opportunities!” Both are probably right. In the short-run, Camp A is probably right. In the long-run, Camp B is probably right. Risk and return are always related.