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| The bull rides on!! And investors cling to the recent rally in the face of uncertain fundamentals that pit daunting challenges against strong tailwinds |
The bulls appear to have fully wrested control of market direction with the rally expanding in breadth in recent weeks. Bears have been shoved aside and trampled as stimulus money floods the country, economies across all fifty US states begin to open and relatively positive news on the Covid-19 treatment and vaccine front seems to be a weekly occurrence. Pushed aside – at least temporarily – have been rising US-China tensions, massive increases in layoffs as evidenced by jobless claims, and uncertainty around a “second wave” of coronavirus infections.
Warning: dry details dead ahead!
The S&P 500 rose about 4.5% in May with all sectors experiencing gains. Investors who decided to wade into this market at the height of uncertainty have been handsomely rewarded, too, with some quality names doubling and tripling since March. Many biotech companies that The Ignorant Investor follows now sit near 52-week highs (even all-time highs) and some retail names of interest have seen massive 30%+ rallies just this last week as the S&P 500 battled to cross the 200-day moving average on a closing basis, a noteworthy technical level. The end of the epidemic is seemingly in sight and advancing pharmaceutical research is giving investors an idea on expected scope and timeline for effectively dealing with the coronavirus.
Warning: dry details dead ahead!
The S&P 500 rose about 4.5% in May with all sectors experiencing gains. Investors who decided to wade into this market at the height of uncertainty have been handsomely rewarded, too, with some quality names doubling and tripling since March. Many biotech companies that The Ignorant Investor follows now sit near 52-week highs (even all-time highs) and some retail names of interest have seen massive 30%+ rallies just this last week as the S&P 500 battled to cross the 200-day moving average on a closing basis, a noteworthy technical level. The end of the epidemic is seemingly in sight and advancing pharmaceutical research is giving investors an idea on expected scope and timeline for effectively dealing with the coronavirus.
This is great news, but all this optimism combined with recent strong market performance makes The Ignorant Investor uneasy. As investors, we must always temper our optimism with observations of market fundamentals. In this case, what's going on with the real economy? Let’s look at two underlying facts. Firstly, the US economy is primarily driven by consumer spending, which accounts for somewhere around two-thirds of annual GDP growth. Secondly, many of these consumers are experiencing tremendous difficulty because of US economic shutdowns. Around 40 million people have filed for jobless claims since the beginning of March. Forty million- that’s about 20% of the “counted” labor force! The government will help make up the income shortfall to these folks for a few short months, but while some have found alternative employment options or have been or will be rehired, others will be left more or less on their own. Such drastic shifts in personal financing will sharply influence consumer lifestyle choices and spending going forward. We may see a partial reflection of this theme this coming week (the coronavirus shutdowns will of course take front and center stage) as many retail companies report first quarter earnings for 2020. Some companies will shine. Others may fall, fast.
In a vote of skepticism, institutional (so-called "smart") money has been increasingly betting against the current market. After all, this rally has taken us to levels first attained in October of 2019, when the economy was running strong, US-China trade tensions appeared to be waning, and unemployment was at historic lows. While The Ignorant Investor remains very confident that in the long term the equity market will continue advancing, right now he very strongly prefers individual names to the broader market. Quality, not quantity, remains the name of the game. And, as always, if you're tempted to jump into the markets, be certain to discuss your strategy and goals with your financial advisor first!
In a vote of skepticism, institutional (so-called "smart") money has been increasingly betting against the current market. After all, this rally has taken us to levels first attained in October of 2019, when the economy was running strong, US-China trade tensions appeared to be waning, and unemployment was at historic lows. While The Ignorant Investor remains very confident that in the long term the equity market will continue advancing, right now he very strongly prefers individual names to the broader market. Quality, not quantity, remains the name of the game. And, as always, if you're tempted to jump into the markets, be certain to discuss your strategy and goals with your financial advisor first!
Additional Considerations
1. US-China tensions are rising. The inflammatory rhetoric from both the United States and China around coronavirus has the potential to derail the preliminary trade pact reached in December of 2019. Then of course China’s planned security law which allows mainland security forces to operate the semi-autonomous region of Hong Kong has had President Trump openly muse about tariffs as potential retribution. The catastrophic economic cost of returning to a trade war immediately following global economic shutdowns is likely to keep both sides “playing nice” in the near term but these tensions are unlikely to subside anytime soon and should remain on investors' radar.
2. The coronavirus is managed, not beaten. While markets largely reflect a US economy that will be able to return to a new normal over the summer of 2020, everything comes down to how well the American people are able to maintain social distancing and other measures that forestall a return to sharply rising infection numbers. Treatment development will precede a vaccine and will likely only have limited availability until 2021, therefore a "second wave" of the virus still has the potential to wreak havoc on society and business.
3. Investing “against” the Fed is like swimming against the tide. The Fed has embarked on a quantitative easing program of similar levels to a war-time scenario. Huge amounts of liquidity are being rightly dumped into the economy at a time of great necessity. But as risks fall – and debt holders take a hard look at their historically low Treasury yields – then, as we observed after the Great Recession at the end of the 2000s, investors will be forced further out on the risk curve in search of yield. Don’t be surprised if equity markets continue to respond to this powerful tailwind accordingly!
Notable Stories from May
Companies behaving badly. Corporate governance matters, and investors prefer that executive compensation is tied to company performance. Whenever markets broadly fall as they have over the past several months, investors are occasionally rudely awakened by executives reaping millions of dollars in bonuses right before their underperforming companies declare bankruptcy. In a cynical piece of news, Hertz is reported to have paid out more than $16 million in retention bonuses to hundreds of executives just before declaring bankruptcy a week ago. But this is better than the $7.5 million JC Penney paid in bonuses to their four-person executive team just prior to declaring bankruptcy. Which in turn is better yet than that eyebrow-raising occurrence when Whiting Petroleum paid $14.6 million in retention bonuses to their five-person executive team a few days before also declaring bankruptcy. Usually, these bonuses are an attempt to keep the company going with a semblance of “normalcy” throughout the bankruptcy proceedings (preserving stakeholder value). Other times, investors are left scratching their heads wondering about the fairness of it all.
Work from home policies are changing. Twitter founder and CEO Jack Dorsey was the first to announce that employees would have the option to perpetually work from home if they didn’t want to return to the office. But he didn’t stop there! As co-CEO of Square, he has now told Square employees they will have the same option. Prescient? Naïve? Only time will tell, but Covid-19 work from home curfew requirements will provide some valuable data on that front. Forbes discusses the particulars of Dorsey’s announcement and some of the pros and cons of the trend here. Should work from home become a trend, this will create new business opportunities and have an outsized impact on companies currently servicing these consumers' work-from-office needs.
SEC overhauls the whistleblower program. Trust in an equal playing field forms the cornerstone of the US equity market and makes it the most powerful wealth generation tool available to the common person in the history of the world (The Ignorant Investor’s opinion). The formula is simple: invest hard-earned money over time in quality companies and reap rewards in decades to come. Enhancing the reliability of compensation for whistleblowers will enable market fairness to continue in an increasingly more complex world and incentivize potential bad players to stay on the “straight and narrow.” The Wall Street Journal has an interesting article detailing the SEC’s streamlined whistleblower program here.
