The US stock market has continued its significant and highly improbable advance from its recent March lows, even as the “real world economy” continues to post record breaking negative figures in many categories, including employment and most recently GDP (Gross Domestic Product), amid the continuing coronavirus. Trying to make sense of this disconnect is now a favorite topic for the financial media. The following S&P 500 figures highlight the point:
|Trump election, November 2016 (Base Period)
|February 19, 2020 (All-Time High)
|March 23, 2020 (Low)
|July 31, 2020 (Current Close)
Even a casual follower of stock prices also knows that these recent gains have been powered by a modest number of large high tech stocks (e.g., Apple, Amazon, Facebook, Microsoft, Tesla, Netflix), as evidenced by the NASDAQ Composite being up an astonishing 20% YTD. As long as stock market participants believe these companies can prosper in the midst of a pandemic and end up stronger at the end of the pandemic, it is at least possible that these upward trends can last.
Other explanations for the stock price advances include:
- the Federal Reserve making it clear it will do everything it can to support the economy and the financial markets;
- the Fed keeping interest rates low, so that investment returns from bonds will be low, providing stocks with the opportunity for growth, even with their downside risks;
- the assumption that the US government will also continue to provide significant financial support to individuals and businesses, even with rising deficits, given the current absence of inflation;
- sporadic optimism about medical advances to counteract the virus;
- modest optimism regarding openings of various parts of the economy; and
- speculation (discussed last month in detail, which still begs the question of why the speculation has been more on the positive side).
The June 15th issue of Bloomberg Business Week (BBW, front page) featured the title question, “The Great Disconnect: Why do stocks keep going up?” First, we note that the S&P price referenced on the BBW cover at that time was 3,207 (6/9/20), which was up 43% from the March 23rd low, even in the face of the extremely disheartening news about the economy (5% GDP decline for first quarter; 14.7% unemployment for end of May; 16.3% retail sales decline for May); the virus (100,000 US deaths); and widespread protests over racial injustice. Not only have stock prices continued to increase from June 9th (see chart above), but the bad news about the economy, the virus, and the protests has also continued. We turn now to what BBW had to say on this subject, in a series of three separate but related articles in the June 15th issue (pages 24- 27).
The first BBW article, “Why Robinhood Day Traders are Greedy when Wall Street is Fearful,” states: “Wall Street strategists – who are as flabbergasted as the journalists – have found with vivid hindsight, the obvious explanations in the numbers. They have pointed to a surprise uptick in jobs, interest rates plunging, cheap valuations of certain kinds of stocks, and short sellers being forced to buy shares. But none of that fully explains what is happening in the minds and emotions of investors… Then there is the army of individual investors who have just stuck to their buy and hold plans, perhaps putting some money in stocks automatically with each paycheck (401k plans)…It’s a popular truism that the stock market is not the economy…[Traders] are often willing to ignore what’s happening in the world every day… Quoting Nobel economist Robert Shiller, “the stock market is just that – a market for shares of companies. It does have some relation to the economy, but it is not as strong as people think. It depends on the story and the story is always changing,” (Our note: there are shades here of John Maynard Keynes and the psychological dimensions of investing, discussed in our May Comments).
The second BBW article, “Pessimistic Pros Missed the Big Rally, and So Did Many Americans,” notes: “The Federal Reserve put a floor under the market by liberally making loans and buying bonds. That mattered more to investors [our note: traders?] than record job losses did…. The case for today’s high stock valuations is that profits will snap back as the economy reopens and that the Fed will continue to keep interest rates low, spurring growth and making stocks look attractive in relation to interest-earning securities such as bonds.”
The third article, “A Booming Stock Market Could Come Back to Bite the Recovery,” makes the point that the better the stock market is doing, the less likely Congress, the President, and even the Fed may find it necessary to continue their various stimulus efforts. This is not a reason for the gains, but a reason to beware the impacts of the gains.
As for bonds, their mostly higher prices make sense, because of the historic low interest rates being maintained by the Fed to help stimulate the economy. But these rates are now so low that any further price advances for bonds may be difficult. So long as inflation remains under control, the Fed seems committed to retaining these ultra-low interest rates.
Initial Comments on the Upcoming Election
With all that is going on, there is an additional wildcard, namely the upcoming presidential election. As our regular readers know, we at Park Piedmont Advisors maintain that who is president is only one of a number of factors affecting stock and bond prices. Even if we know who is going to be president, no one can predict what will happen during that presidency. Exhibit A for this statement is Trump himself. At the time of his unlikely election in November 2016, the conventional wisdom was that if he won, stock prices would decline. That clearly has not been the case (see chart above). It took the coronavirus in early 2020 to slow down the 2019 stock price increases. Even now, prices are advancing rather than declining, while most early polls indicate a possible Biden win. There is also the related question of whether the same party can control the presidency and both Houses of Congress to effect truly meaningful change.
Another example of the possibly mixed impact of an election: if a Democrat were to win and roll back the recent corporate tax cuts, which some would consider a negative result for stocks, the new money available to the government could well go into stimulus construction projects that would be a positive to overall economic activity, corporate earnings, and stock prices. It is worth repeating that corporate earnings and a sustainable price/earnings ratio are valid reasons for stock price gains.
We will continue to comment on the election as the time gets closer, as it is likely to become a popular topic in the media. But we repeat that in our view, there is nothing inherently predictive about the connection between market prices and election results, certainly not as time passes and other intervening events become more important.
As for the more general future, which is always an unknown, but even more so in the midst of the pandemic, we quote Warren Buffett from Berkshire Hathaway’s second quarter SEC filing: “We cannot reliably predict when business activities in our numerous and diverse operations will normalize. Nor can we predict how these events will alter the future consumption patterns of consumers and businesses we serve” (NYT 8/8/20, page A24), If Mr. Buffett acknowledges that he doesn’t know, it seems safe to say that no one knows.
Our advice remains the same: maintain asset allocations developed for your circumstances for the long term, and rebalance from time to time based on significant changes in market prices, which means selling the better performing asset class and buying the weaker performer in a given time frame.