Key Points
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The news doesn’t get better, but the market’s ability to shrug it off continues to breed questions about the perceived disconnect between Main Street and Wall Street.
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Surging liquidity and hopeful virus treatment/vaccine news have been significant tailwinds behind stocks.
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But heightened complacency could breed risks, with no shortage of potential negative catalysts.
The news continues to be overwhelming and devastating. Deaths from COVID-19 in the United States have moved into the six figures, 40 million Americans have filed for unemployment insurance and our country is in a state of grief and rage over racial injustice. It’s getting easier to understand the skepticism associated with the perceived disconnect between real life pains on Main Street and the resilience of (or disregard by?) Wall Street.
Is the stock market “rigged?”
That’s a refrain I hear often, and there is a kernel of truth there—perhaps best illustrated via the adage coined by my first boss and mentor—the late, great Marty Zweig—Don’t fight the Fed. The Fed’s efforts in trying to prevent the COVID-19 health and attendant economic crisis from becoming a financial system crisis are a combination of pages pulled from the 2008 financial crisis playbook, plus new chapters created for today’s unique crises. Along with relief programs initiated by Congress and the Treasury Department, the combined “stimulus” currently equates to more than 25% of real U.S. gross domestic product (GDP) this year, as estimated by the Congressional Budget Office (CBO).
As you can see in the chart below, the growth rate in M2 money supply has gone parabolic. At the same time, the velocity of money continues to sink—which is why “real economy” inflation has been kept in check. “Money printing” by the Fed (not quite an accurate description of what the Fed’s doing) only becomes inflationary if the liquidity pumped into the financial system comes out via the lending channels and picks up velocity in the economy. Without that velocity, inflation tends to be absent in the real economy—but quite evident in asset prices (like stocks).
Money Supply Goes Parabolic
Source: Charles Schwab, Bloomberg, Federal Reserve Bank of St. Louis, as of 4/30/2020. The velocity of money is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity is increasing, then more transactions are occurring between individuals in an economy.
The surge in money supply is reflected on Main Street as well; with the personal savings rate surging to a whopping 33% of disposable personal income; while at the same time, household net worth remains historically high (first chart below). The combination of direct payments from the government to most taxpayers, and enhanced unemployment insurance, has paved the bridge for those affected by the coronavirus crisis with more than just good intentions. Recent surveys show that about 60% of laid off workers have been made more-than-whole relative to their work-based income prior to the pandemic. In addition, households have been in deleveraging mode since the Global Financial Crisis (GFC); with debt levels well below long-term trend lines.
Savings Rate Goes Parabolic
Source: Charles Schwab, Bloomberg, Bureau of Economic Analysis (BEA), Federal Reserve. Personal savings rate as of 4/30/2020. Household net worth as of 12/31/2019.
Households’ Post-GFC Deleveraging
Source: Charles Schwab, FactSet, Federal Reserve, as of 12/31/2019. Yellow and green lines represent trend lines. Household debt includes home mortgage and consumer credit.
Stocks doing their job as a leading indicator?
As noted, a significant tailwind behind stocks since the March 23 low has been courtesy of monetary liquidity and fiscal relief. But there is more at play. The speed with which the virus spread and the economy was shut down was reflected in the fastest move in history from an all-time high for the S&P 500 on February 19 to a bear market—down 35% at the low. Arguably, that was “discounting” a lot of the economic carnage through which we’re all still living today. But the move up from that low—36% as of Friday’s close—has elicited the cries about the disconnect between Wall Street and Main Street.
Some of what’s at work is in keeping with the long history of bear markets accompanied by economic recessions. With only one exception in the post-WWII period, bear markets typically started in advance of recessions’ start dates; while bear markets typically ended in advance of recessions’ end dates. With the exception of 2001—when the recession ended, but the stock market didn’t bottom until the end of 2002—bear markets ended while the economic data remained in the dumpster. You can see the full post-WWII history of bear markets that have been associated with recessions below.
Source: Charles Schwab, Bloomberg, National Bureau of Economic Research, as of 5/29/2020. For illustrative purposes only.
The leading nature of the stock market was perhaps best defined by Sir John Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” In today’s environment, the stock market may also be high on “hopium” with regard to the expected success of the economy, now that it’s reopening; but also with regard to finding therapeutics and/or a vaccine for the virus itself. Case in point: since mid-April, the four best-performing days for the Dow Jones Industrial Average, came on days there was a significant announcement associated with the virus:
- April 17: Gilead’s drug Remdesivir showed effectiveness in treating COVID-19 (+705 points)
- April 29: Positive data about Remdesivir’s trials (+532 points)
- May 18: Moderna announces early-stage human trials for its COVID-19 vaccine (+912 points)
- May 26: Novavax announces phase one clinical trial for vaccine; Merck announces plan to work on vaccine alongside IAVI (+530 points)
Add those days together and they amount to 2679 Dow points—well more than the 1762 Dow points gained since that initial Remdesivir headline. Another dose of “hopium” is tied to hopes for a swift economic rebound now that things are opening up again. This has been reflected in recent performance under the hood of the overall market. The charts below highlights three distinct periods of note with regard to performance trends: the bear market phase (2/19/20 to 3/23/20), the recovery phase (3/23/20 to 5/14/20) and what I’ll call the cyclical shift phase (since 5/14/20).
Sector Performance in Phases
Source: Charles Schwab, Bloomberg, as of 5/29/2020. Past performance is no guarantee of future results.
Russell Index Performance in Phases
Source: Charles Schwab, Bloomberg, as of 5/29/2020. Past performance is no guarantee of future results.
Leadership in phases
As noted earlier in this report, one could argue that the market was discounting much of the coming economic weakness at the March 23 low—with energy pulling up the rear; and weakness in industrials and financials also mirroring the coming economic carnage. Investors’ preference for relative quality, growth characteristics and ample liquidity also led to significant relative outperformance by large cap growth stocks.
The surge from the March 23 low until mid-May was a combination of a “reversion trade” (see the mirror image performance of the energy sector), but also a move biased toward sectors hurt least by the pandemic, like health care and technology. Since mid-May, leadership has shifted toward the more-classically-cyclical areas of the market—including industrials, real estate and financials; while also giving rise to outperformance by small cap stocks.
These three phases are important to unpack. Phase one reflected the economic freefall associated with a wholesale shutdown of the economy. Phase two reflected what remains the consensus scenario—a bifurcated economy with subset of “winners,” but in the context of very subdued growth overall. Phase three has been reflecting hopes for more of a V-shaped recovery, with the economy moving back to prior levels in relatively short order (call me a skeptic).
No more halitosis
This shift in leadership has manifested itself in improving market breadth. As you can see in the first chart below, the cumulative advance/decline (A/D) line for the S&P 500 has been catching up to the rally in the stock market over the past couple of weeks. As such, more than 95% of stocks in the S&P 500 are now trading above their 50-day moving averages; although less than 50% are trading above their 200-day moving averages (see second and third charts below).
Breadth Improving
Source: Charles Schwab, Bloomberg, as of 5/29/2020.
Source: Charles Schwab, Bloomberg, as of 5/29/2020.
Source: Charles Schwab, Bloomberg, as of 5/29/2020.
Tactically, the parabolic move up in stocks trading above their 50-day moving averages points to extremely over-bought conditions; even if surges like this historically were longer-term positives. Similar surges occurred off the 1991, 2003, 2009 and 2016 market lows; and were generally followed by a few months of choppy/consolidative action, before stocks resumed their ascent.
But plenty of complacency
We may be setting up for a similar consolidation as we’ve seen in recent history. One of my concerns is investor complacency—bred from stocks’ rocket launch off the lows. There is no shortage of catalysts for a consolidation and/or a period of heightened volatility; including second waves of the virus, second-order/lasting economic effects of the shutdown, simmering tensions between the United States and China, budding election uncertainty, and of course civil unrest on the heels of the death of George Floyd.
Monetary and fiscal stimulus—and more recently news on virus treatments/vaccines—have fueled an epic run up from the lows. Ultimately though, equity prices depend on economic conditions and corporate earnings. There is a risk that the stock market is not accurately reflecting second-order and longer-term economic impacts of the virus and attendant economic shutdown (including bankruptcies and temporary layoffs becoming permanent job losses). There is also a risk that the stock market is not accurately reflecting the weakness yet to be fully felt in corporate earnings.
That said, it’s always wise to heed the market’s messages. Fiscal and monetary support has been unprecedented and could ultimately overcome the damage to the economy. Most readers know I rely on history’s data as a guide to the present, but this time is truly different. Conviction levels are running high as the market has continued to rally—interestingly cementing the views of both the most ardent bulls and bears. I put myself in neither camp; although my long-term optimism about our economy and capital markets remains high.
Our advice to investors trying to navigate these uncertain waters has been consistent this year: rely on tried-and-true disciplines like diversification (across and within asset classes) and regular rebalancing (trimming into strength and adding into weakness). Keys to long-term investment success do not rely on the precise timing of market tops and bottoms. Investing is—and always has been—a process over time. It should never be about moments in time.
© Charles Schwab & Co.
© Charles Schwab
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