“Markets can remain irrational longer than you can remain solvent.”
That observation came from the late economist John Maynard Keynes. Today, it’s fear, not the fundamentals, that are driving short-term sentiment.
Silicon Valley Bank and Signature failed, and the government stepped in to guarantee all deposits of the two banks. And, the Fed implemented a new lending program. Crisis solved.
Advance to late April.
First Republic says it lost a substantial number of deposits since the beginning of the year. The FDIC steps in and sells the deposits and most assets to JPMorgan. “This part of the crisis is over,” JPMorgan CEO says.
Well, not so fast.
Analysts are now warning that regional bank stocks are stuck in a negative feedback loop. The fundamentals don’t seem to matter. Fear and sentiment do. Following First Republic’s demise, short sellers and the market eye their next target, which right now is California-based PacWest Bancorp.
“Markets can remain irrational longer than you can remain solvent.” It’s just one more reason why a well-crafted diversified investment portfolio tailored to your long-term goals can help you manage short-term volatility.
Got volatility? You bet. The DJIA can rise or fall by 800 points in a day. What’s going on? Millions of large and small investors are buying and selling, attempting to discount, or price in, future events. This occurs in ‘normal’ and ‘not-so-normal’ times.
But even in normal times, uncertainty is always present. No one knows the future with certainty. Do you have a crystal ball? I didn’t think so.
What might happen to bond yields, corporate profits, economic growth, inflation, and more?
Today, the economy is on solid footing. Consumer balance sheets are strong, jobs are being created, and the economy is expanding. However, the markets are facing huge headwinds: rising inflation, a more hawkish sounding Fed, and the Russian invasion of Ukraine.
Russia’s invasion has injected an enormous amount of short-term uncertainty into markets.
For example, how do investors price oil? Well, what’s going to happen to Russian oil exports?
The U.S. is looking to ban Russian oil imports, but Europe has been reluctant. Yet, banks don’t want to finance shipments, and dock workers aren’t unloading the crude.
How long might this last? How do investors price oil in such an unstable environment? It’s why we are seeing huge swings in crude.
Eventually, we might expect investors to gather around some version of a new normal. I guess in some respects, a roughly 10% drop in the S&P 500 suggests an incredible amount of resilience. Think about it: inflation is soaring, uncertainty is the rule, the Fed will be raising rates, and markets are down modestly.
The tech-heavy Nasdaq has set numerous records this year. The S&P 500 eclipsed its February high on August 18 and proceeded to set six more records before August ended.
An impressive stock market rally
And the better-known Dow crossed 29k today and is closing in on its previous all-time high.
Per Barron’s, the Dow had it’s best 100 day run since 1933 – up 50% from its March 23 bottom through mid-August. It’s stunning given the uncertainty regarding the economic backdrop.
It’s not that we remain mired in a recession. We’re not. The economy is in recovery mode, but there’s still plenty of ground to be made up. Yet, this story has been told before.
However, let’s remember that investors attempt to discount future events, usually between 6 to 9 months.
The major market indexes bottomed March 23, and major data points began to rebound in May.
Factors lifting stocks
My list begins with, “It’s the Fed, stupid.”
Federal Reserve stimulus and an open-ended commitment of additional support, which includes extraordinarily low interest rates and Fed guidance that low rates will continue for an extended period. Let’s not forget Powell’s late August speech, in which he stressed that the Fed will take a softer line on inflation and won’t be as quick to pull the trigger on raising rates.
But let’s not stop there.
2. An improving economy has also helped. Put another way, better economic numbers and Fed stimulus have combined to create a powerful cocktail for investors.
Wait, there’s more.
3. A smaller-than-expected drop in Q2 S&P 500 profits (Refinitiv),
4. A rollover in new daily Covid cases (Johns Hopkins) and talk of a vaccine, and finally, investors may simply be looking past the steep recession of 2020.
Yet, let’s not discount risks. When stocks surge, any unwanted surprises can create volatility and an excellent excuse to take profits. One has to wonder, even expect, that we may see some rocky days.
For now, the bulls stepped in front of an expanding economy when few saw the robust bounce that occurred in May and June. The collective view of investors on the economy remains optimistic, even if the month-to-month rate of growth is uncertain.
I never thought I’d EVER blog about getting a haircut. But then, these are unprecedented times we’re living in.
If you reside in one of the states or cities that has shuttered businesses, you probably haven’t been to a barber or hairstylist in over a month. If you’re like me, you snuck in just before businesses closed.
But for someone who gets a trim (I joke with the stylists that I call it maintenance) every 4 or so weeks, I was starting to push the limits. It makes you appreciate the simpler things such as getting a haircut, but I wonder what I might have looked like had I missed a late March trim?
It’s probably a good thing that I’ll never know!
Where should I start?
First of all, an appointment was required. No walk-ins. Not anymore. So, I called and was asked a number of questions… questions I’m grateful that were asked.
Did I have a persistent cough? Was I displaying any symptoms? Had I been around anyone in the last 2 weeks that had COVID-19? Was anyone in my household sick?
I answered honestly, and we made an appointment for later in the afternoon.
But wait, there’s more.
As I arrived, I was greeted by a large sign on the door that offered me additional guidance.
All customers must have a mask. Do not come in. Call and we’ll come outside and escort you through the door.
The new normal
OK, you won’t get any complaints from me.
I called, and shortly, a young lady exited the building with a sign that had my name on it. She too donned a mask.
We exchanged pleasantries and I politely asked her if we could keep conversation to a minimum. I missed the chatter that I’ve grown accustomed too, but I thought, “Masks aren’t perfect, she’s above me trimming my hair, and what about those droplets we’re all worried about?!”
Within 15 minutes, the beast had been tamed. What looked like the early stages of the Amazon jungle was now a neatly manicured lawn. Whew!
It’s not that I’m going anywhere anytime soon. It just felt good to experience a bit of normalcy and get my hair cut. I must admit that I feel better when I look in the mirror.
I assume my stylist hadn’t been working in over a month, but I didn’t ask. I assume she had been receiving unemployment, but again I didn’t ask. Benefits are generous today, but I was appreciative she came in, and I expressed those sentiments to her. I was happy to leave her a hefty tip.
Maybe, just maybe, as states slowly reopen their economies, the downward economic spiral will end, furloughed employees will return, and economic activity will begin to accelerate.
Still, I’m under no illusion that the economy will soon hit pre-crisis levels. But maybe the flicker of light in the sky is the dawn before the sunrise.
Main Street has suffered through 26 million first-time jobless claims over the last five weeks. We’re witnessing Depression-like layoffs. You’d think Wall Street and investors would have been badly mauled. Most stocks are down, but badly mauled?
Wall Street takes a different path
Since bottoming, the S&P 500 Index has surged 25% though April 23. Technically, we’re in a new bull market given that the advance has exceeded 20%… technically.
The index of 500 major companies is down 17% from its peak. That’s a serious correction but nothing out of the ordinary.
I believe there are four reasons that have prevented a meltdown in the major averages.
Extraordinary measures taken by the Fed far exceeds the more cautious response during the financial crisis.
The execution has been far from flawless, but the federal government is doling out over $2 trillion in fiscal stimulus, and more may be on the way. Remember the $787 billion fiscal stimulus during 2009?
Signs the virus may be peaking have also helped, and investors will be closely watching states that will gradually relax lockdown guidelines.
Earnings will get hammered in Q2. But investors are looking beyond the second quarter to next year.
No one knows. The 1918 pandemic and the 1957-58 Asian flu hit the U.S. economy hard, but the respective recessions were the shortest on record.
The bond market is taking a more cautious view, but investors are expecting some kind of rebound soon.
Fiscal and monetary stimulus is laying the foundation for a recovery. A vaccine and an effective short-term treatment would go a long way in boosting Main Street sentiment.
There are plenty of variables in the stock market and economic equation, but without a ‘decent’ recovery, renewed market pressure seems likely.
Saying “our economy will face severe disruptions,” the Fed announced early today an open-ended commitment to buy assets.
Stocks roiled by virus fears
It will purchase $375 billion in Treasury securities and $250 billion in mortgage-backed securities this week—a near QE Infinity—to support credit markets. That’s on top of last week’s $700 billion announcement.
It will also begin buying commercial mortgage-backed securities. And, for the first time, the Fed will start buying investment-grade corporate bonds in the primary and secondary markets, and through ETFs.
Among its measures, there were a number of other programs, including two facilities to support credit to large employers. It soon expects to announce the establishment of a Main Street Business Lending program.
At this point, the Fed is trying to cover all aspects of the credit markets amid the turmoil being generated by the COVID-19 epidemic.
Yet, despite disruptions in the Treasury, corporate, commercial paper, and money funds markets (and ETFs) we have not had a systemic event nor have markets come close to stress levels seen in the financial crisis. The Fed is desperately trying to stay ahead of the curve.
I wish the same could be said of fiscal policy. Fear of the virus has the economy in a smackdown. The economic uncertainty is enormous, and discounting future earnings is incredibly difficult right now.
Here lies the problem. Markets attempt to price in future events, and forecasts are all over the place when it comes to what will happen next month, Q2, and when we might see an economic recovery.
JPMorgan Chase & Co. expects GDP to shrink at an annualized rate of 14% in Q2, while Bank of America and Oxford Economics both see a 12% drop. Goldman Sachs Group Inc. sees a 24% plunge (Bloomberg).
St. Louis Fed President James Bullard said Sunday night the unemployment rate could rise to 30% and GDP could take a 50% hit. Reality – no one really knows.
Never have we seen such discrepancies! Typically, the range for GDP is about a full-percentage point.
Programs aimed at supporting small and larger businesses are an excellent step in the right direction, and it could save some jobs until demand bounces back.
But will small business owners access these lifelines? How many bureaucratic hoops will they need to jump through? How can apps be quickly processed? How fast can cash be infused into companies that can’t meet payroll?
What looks good on paper must be quickly put into practice.
Capitalism vs government intervention
Though we argue around the edges about the need for regulation, most folks believe in free markets. I’ve met business owners who are Democrats and I’ve met business owners who are Republicans.
They wouldn’t own a business if they didn’t adhere to free-market principles in some form.
But today, even staunch proponents of free-market capitalism acknowledge that intervention by the Fed and fiscal stimulus from the government are needed amid the fear created by an exogenous event–COVID-19.
They do not adhere to a rigid ideology when circumstances dictate, especially when state and local governments are forcibly shutting down businesses.
Yes, intervention isn’t cheap but the bill will be much higher if key industries collapse.
The COVID-19 crisis will eventually peak, people will venture out and spend, and we will see an economic bounce.
Greater transparency on the economy, which won’t be immediately forthcoming, should help. Stabilization of new cases and major fiscal stimulus could go a long way in lending support.
But fiscal stimulus from Congress is needed yesterday. Congressional bickering has to stop. Leave your agendas at home.
In its first intra-meeting move since the financial crisis, the Fed cut the fed funds rate by 50bp to 1.00-1.25%.
Fear spreads faster than the virus
While Powell said, “The fundamentals of the U.S. economy remain strong,” he added, “The spread of the coronavirus has brought new challenges and risks,” and “the risks to the U.S. outlook have changed materially.”
Powell conceded the Fed doesn’t have all the answers – monetary policy can’t address a supply shock nor can it slow the rate of infection.
A fiscal policy (My view: tax cuts/debit cards with an expiration date (if that is possible)) and health care response is needed, but he believes the Fed’s cut will—“provide a meaningful boost to the economy” by supporting business/consumer confidence and interrupting the recent tightening of financial conditions.
Maybe. But a rate cut isn’t enough to aid industries dependent on person-to-person contact.
The market’s reaction: negative. Was the intra-meeting cut a sign of desperation? Inan abbreviated Q&A session following the rate cut, Powell’s remark that he fully expects the economy to “return to solid growth and a solid labor market as well” has me wondering if he’s already seen the February jobs’ report, which is out Friday.
That said, the survey is taken during the pay period the includes the 12th day of the month. That’s in front of the Feb 19 S&P 500 peak.
What’s happening? There is an enormous amount of economic uncertainty being generated by FEAR of the virus, not the rampant spread of the virus. Flu infections far, far, far, outpace what we’ve seen so far from COVID-19.
Uncertain outcomes include:
Will we fall into a recession that sends corporate profits lower,
Will the economy stall before accelerating in the summer or fall, or
Will we only see a modest/temporary slowdown that delays the projected acceleration in profits?
It’s an unanswerable question; therefore, investors shun risker assets.
Recession risk
Clearly it has risen, but action over the last couple of days in some junk bond funds is encouraging. Still, the situation in high-yield debt remains fluid.
We may see a slight bump in consumer spending as some folks stock up on staples, but it’s very difficult to model how much the economy may slow, or whether we may see a contraction in Q2 or beyond.
Hence, the flight out of riskier stocks and into the safety of Treasuries. Is a bottom in sight? Have we already hit bottom? Or we headed into a bear market? Those who know how I approach investing know that I don’t try to time the market. It’s impossible. A well-diversified investment portfolio that’s tailored specifically to your goals and risk tolerance (and other factors) is the best long-term path. Please contact your financial advisor for guidance.
What we do know is that stocks have historically had a long-term upward bias. Volatility and downturns are inevitable, and bull markets don’t last forever. And, for 200 years, bull markets have followed bear markets.
While COVID-19 does appear to be deadlier than the flu, we may look back on this much like MERS, SARS, or H1N1. None received today’s media attention, which may be stoking public fears, and little damage occurred to the U.S. economy.
Lighter note
Masks (assuming they do any good) and hand sanitizers are hard to come by, but there’s plenty of toilet paper at my local Walmart. That’s a good sign we’re not seeing a full-blown panic.
The US and China agreed to a new trade deal on Friday, at least in principle. Referred to as phase one, it’s a skinny deal that covers agricultural products, technology, and financial services.
It’s not the comprehensive reforms we hoped might be achieved earlier in the year. But given the acrimony and escalation in tensions just a few weeks ago, progress is welcome.
Sigh of relief
Had talks broken down… again, new tariffs would have gone into effect on Tuesday. If history is a worthy guide (and I believe it is), China would have erected new barriers to U.S. goods, and another round of tit-for-tat retaliation would have ensued.
The end result: we would have experienced renewed market volatility. For now, the U.S. and China avoided that pothole.
Investors’s corner
While geopolitical headlines can create volatility, economic fundamentals drive US equity prices over the medium- and longer-term. However, this year headlines have had a much greater impact on market activity.
We witnessed tensions derail stocks in May and in August. While modest economic growth cushioned the downside, the fundamentals have taken a backseat.
With a truce in place, might investors rest a little easier? Let’s root for progress, as phase one talks tackle the nitty-gritty.
For example, China promises to buy $40 to $50 billion in US agricultural products. That’s a lot of soybeans, pork, and corn. Yet, a time frame was not specified.
Still, phase two talks need to move forward. Momentum and smiling public faces must translate into real progress behind the scenes. It may be easier said than done.
And, let’s not forget that a new round of tariffs scheduled to go into effect on Chinese imports in December remain in place. For now, a US-China trade deal is a welcome relief from the unending acrimony we’ve experienced.
Late-week headlines finally proved to be correct. Stay tuned.
Longer-term, profits and profit forecasts are the leading driver of equities. Shorter-term, sentiment can be influenced by various factors.
To varying degrees, the macroeconomic environment, the Fed, global central banks, and geopolitical issues impact market action. Recently, trade has had an outsized influence.
Last month’s selloff was tied to a flare-up in tensions between the U.S. and China. An unexpected tweet by the president threatening Mexico with debilitating tariffs added to the uncertain mood.
Peak-to-trough decline in the S&P 500 Index from April 30 thru June 3: a modest 6.8%. It’s nothing out of the ordinary.
But shortly after Trump threatened Mexico, Fed Chief Powell shifted his stance. No longer was the Fed on hold. Instead, Powell implied the Fed would cut rates if the need arose, sparking a turnaround in stocks that pushed the S&P 500 into new territory.
Since the beginning of the year, a wait-and-see Fed supported equities. During May it cushioned the downside. A newfound flexibility in June has countered sentiment on trade.
The bond market is screaming economic slowdown. But stock market reaction suggests we’re not slipping into a recession. Stay tuned.
Have you heard the adage: profits are the mother’s milk of stocks. It’s a fancy way of saying that profits are the long-term driver of stock prices.
Today, Q1 earnings are topping a low bar. When the season concludes, earnings growth will probably be in the plus column – barely, but it will likely be the worst showing in almost three years.
Yet, it’s more about the so-called second derivative than the actual number. In other words, clearing the low hurdle has been the frosting on the low-interest rate cake, i.e., it’s the frosting that pushed the S&P 500 to a new high this week.
Yet, risks rarely dissipate. If they do – at least via investor perceptions, a rude awakening usually brings us back to reality.
Long-term investors know that volatility and corrections are a part of the process. Those with a long-term time horizon also know that timing the market is exceedingly difficult. That leads to the conclusion that a disciplined approach which incorporates setbacks has historically been the most fruitful path in achieving one’s financial goals.
