May Markets and Observations on Uncertainty

Victor Levinson Comments

The US stock market continued the highly unlikely gains that started in April through May, following the steep declines from mid-February to late-March. With only modest examples of reopening the economy amid the coronavirus, the ongoing stock gains appear to be taking a highly optimistic view of the future. The various actions by the Federal Reserve to keep interest rates extremely low and to buy various categories of bonds appear to have stabilized financial markets and provided a foundation for the stock gains. The Economist discussed this situation as follows: “Financial markets look forward. Yesterday’s news is stale. What matters is the future, in particular the returns that today’s buyers of securities can expect… Stock prices have had a substantial recovery from their lows, even as the economic news continues extremely negative (e.g. GDP down 4.8%; unemployment of 20 million)… So what are reasons for the stock rally?… Federal Reserve efforts to backstop the economy… Bond yields are paltry, making equities appealing by  comparison” (our note; we would add, as long as stocks are going up) (The Economist, 5/7/2020).

The year 2020 is providing several examples of unforeseen events and consequences, and we will be commenting on the subject of uncertainty next.  First, a few data points for the S&P 500 are worth noting:

  • Feb 19th high to the March 23rd low, down from 3,386 to 2,237, a decline of 1,149, or 34%;
  • Feb 19th to April 30th; 3,386 to 2,912, a decline of 474, or 14%; the gain from the low was 675, or 30%;
  • Feb 19th to May 29th, 3,386 to 3,044, a decline of 342, or 10%; the gain from the low was 807, or 36%
  • At the beginning of 2019, the index was 2,507; with end of May 2020 value of 3,044, there has been a gain of 537, or 21%. For all of 2019, the S&P 500 was up just short of 29%.


What does the future hold?

Over the past weeks, as “stay at home” orders have lifted and communities have gradually reopened, there has been much public discussion of what a “new normal” might look like. We’re the first ones to admit we don’t know what’s going to happen tomorrow, let alone next year or over the decades to come. (Neither does anyone else.)

Is it possible the stock market offers clues? As we’ve written before, the stock market is forward-looking. Wharton Finance Professor Jeremy Siegel explained in a recent NY Times article that “[o]ver 90 percent of the value of stocks is dependent on earnings more than a year in the future.” The stock market’s rapid recovery over the past two-plus months, following its precipitous decline in late February and early March, suggests that investors see a promising future. A welcome “new normal.” In many ways, this is good news.

Yet, as the protests of the past week over the killing of George Floyd have shown, we have a powerful opportunity to reflect on the “old normal” – bountiful for many, agonizing for many others. COVID-19; widespread protests against racism and police brutality; an upcoming national election; geopolitical flux; the interruptions to our daily lives and closest relationships have all contributed to what seem like unprecedented uncertainty. But of course, all times are uncertain as we’re living through them.

We have written frequently over the years about how uncertainty plays a major influence in financial market pricing. Since no one can predict the future, uncertainty must be considered. The whole point of asset allocation is to try and exercise some decision-making that takes into account the risks of an uncertain future.  Our favorite spokesperson on this topic is Nick Taleb, the author of both The Black Swan (2007) and Fooled by Randomness (2001).  His work is well-illustrated for us by the parable of the turkey. The turkey is fed excellent meals every day and develops the expectation that these meals will continue indefinitely, only to encounter Thanksgiving.  The Black Swan references the idea that there was a time in the past when only white swans appeared, to the point where people thought only white swans existed. It took the appearance of one black swan to change that ”certainty.”

A recently published book, The Price of Peace: Money, Democracy, and the Life and Times of John Maynard Keynes, by Zachary Carter (May 2020), provides additional insight on the subject. Carter writes: “Financial markets, Keynes had discovered, were very different from the clean, ordered entities economists presented in textbooks. The fluctuations of market prices did not express the accumulated wisdom of rational actors pursuing their own self-interest but the judgment of flawed men attempting to navigate an uncertain future. (Our emphasis). Market stability depended not so much on supply and demand finding an equilibrium as it did on political power maintaining order, legitimacy, and confidence. These observations became central tenets of the economic theory presented in his magnum opus ‘The General Theory of Employment, Interest and Money’ (page 17).

In our advisory work, when an asset allocation becomes too risky, or too conservative, for a particular client, we evaluate, and then, where appropriate, recommend and implement portfolio rebalancing. Rebalancing is a method of adjusting an investment portfolio’s risk exposure based on the assets held, informed by a client’s risk tolerance, time horizon, and overall goals.

Are we undergoing a broader, society-wide rebalancing? There are significant risks in persisting with the “old normal.” To paraphrase Keynes, here we are, “flawed people attempting to navigate an uncertain future.” The stock market suggests that future might be promising. But it remains on us, both personally and professionally, to continue doing the hard, daily work to make that promising future more equitable, accessible, and just.