A puzzling FAQ
COVID-19 has impacted virtually every American and nearly every citizen of the world. The fear is palpable, and the human tragedy is immense. The economic devastation is beginning to take root as unemployment numbers not seen since the Great Depression are occurring in real time. Governments around the world have responded with massive monetary and fiscal stimulus, yet these tools are not infinite. And yet, as of today, the S+P 500 is down just 12% since January. So, the number one frequently asked question (“FAQ”) we’ve been addressing these past several weeks is: “why isn’t the market down more this year?”
A disquieting disconnect
This disconnect between 1) the path of the virus, 2) the economy, and 3) the US stock market is disquieting. We know that stock markets are forward-pricing machines. They project what corporate profits might be 12-18 months in the future. Wall Street analysts build complex earnings models to forecast what a company’s profits will be in a given quarter or year, and markets price that company’s stock accordingly.
How is a pandemic factored into an analysts’ assessment? Even if analysts knew more than Dr. Fauci, no one can ensure that a second wave of infections won’t occur. We are all optimists by nature and want to believe that in the enduring words of revered Wall Street legend Byron Wien that “bad things have a way of not happening.” Despite his inherent optimism, about once every century, they can happen. And a bad thing is happening now.
A resilient GAFAM?
Upon closer view, although we’ve had a massive rally off the March 23rd lows, a large percentage of that move is due to a very small number of high-quality companies with durable businesses and lots of cash on hand. Nearly 20% of the US stock market index is accounted for by five companies. In other words, as goes Google, Apple, Facebook, Amazon, and Microsoft (“GAFAM”), so goes the stock market.
Another consideration is that interest rates are near zero, so fiduciaries are being pushed to take risks in stocks. Combined with the Federal Reserve and Congress blasting $7 trillion of stimulus across the country, one can begin to understand why stocks aren’t dropping even more.
Like Mr. Wien, we too are optimists, but it stretches our imagination to believe that the American consumer (who represents 2/3 of GDP) is ready to muster up those animal spirits anytime soon. After all, last Friday’s jobs report revealed that every job created in the last decade – all 20 million of them – disappeared in the last two and a half months.
To open or not to open
We feel the lingering economic damage is just beginning, and the re-open of our economy is still in its infancy. Ultimately, markets care most about corporate profits and interest rates. However currently markets are focused more on liquidity and not on profits. Our view is that as companies continue to report weak earnings, stock markets will struggle to move higher.
In the meantime, we think the most prudent course is to maintain a high-quality diversified portfolio suitable to your risk profile and rebalance periodically. Take comfort in the fact that we have the most durable economy in the world. We’ve endured dozens of crises in the past. Yes, bad things do happen every so often, but over time, markets continue to rise, the economy will once again grow, and we will endure.
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