August 12, 2020 - Why Does the Stock Market Seem So Optimistic Right Now?

August 12, 2020
Share |

So, you think you know a bit about the stock market? Okay, how about taking a crack at a little quiz?

First question: When the United States is in a recession, will the market go up or down?

“Come on, man,” you say with an insulted look on your face. “I may not be Warren Buffett, William O’Neil or Peter Lynch, but isn’t that a bit elementary? Everybody knows that the stock market goes down during a recession!”

I decided to check your answer, and I found the following table showing US real GDP alongside S&P 500 returns going back to 1930[1].

The general pattern in the chart above appears to be that when the GDP goes down more than one percent, the stock market goes down as well.  Sometimes it goes down significantly. In the chart, there are eight instances when real GDP goes down more than 1%, and in six of those instances the S&P is negative for the year. The average of those six years is approximately negative 25%.  (Of course, it should be noted that the S&P 500 also produced negative returns in years when the GDP was positive.  Some of those declines, too, were significant.)   Regardless, the current recession fit the “significantly negative GDP equates to negative returns” profile, for a while anyway. The GDP went down 5.0% in just the first quarter of 2020[1]. And from mid-February to mid-March, the S&P 500 crashed 34%[2].  It looked like the typical pattern would be repeated.  But what’s happened in the four and a half months since mid-March doesn’t match the pattern observed in the data points above.  In the second quarter of 2020 GDP fell at a 32.9% annual rate[3] and the U6 unemployment rate hit 22.8% in April[4].  And yet, from March 23 to July 31, the S&P was up 46.20%[5]!

So, let’s go on to the next part of our little quiz…

With the Nasdaq Composite at new highs and the S&P 500 positive for the year, why in the world are so many stock market investors seemingly so optimistic right now?[6]

 

FACTORS CONTRIBUTING TO THE RISE IN STOCK PRICES

 

Let’s start by saying that rising stock prices do not necessarily spawn from optimism alone. So, let’s set “optimism” aside for a moment and focus on rising stock prices more generally. Why did the S&P 500 jump over 46% from mid-March to the end of July[1]?

We believe the short answers are (a) the Federal Reserve, and (b) Congress adding a graveyard shift to operate their currency printing presses 24/7.  However, in reality, there are a multitude of factors that we feel explain why there has been an unprecedented rise in stock prices.  Let’s take a closer look:

  1. The Federal Reserve – The Fed has been quick to act and has taken unprecedented steps to save the US economy during the COVID-19 crisis. They lowered the interest rate to 0%. In mid-March they started buying commercial paper and municipal debt, a program that was supposed to max out at $700 billion. The Fed later blew the top off that cap when they pledged to make “asset purchases with no limit to support markets”, according to cnbc.com. It seems as if they’ve loaned or invested money to every business, person and dog with a pulse.

  2. Congressional Purse Strings – It is the opinion of the author that Congress has mortgaged our kid’s and grandkid’s future so we can all eat today. In March, Congress passed three coronavirus relief bills costing over $2 trillion to respond to the virus, guarantee free coronavirus testing, establish paid leave, expand food security initiatives, increase federal Medicaid funding, pay $1,200 to each adult and $500 per kid for households earning under $75,000 per year, increase unemployment benefits by $600 per week for four months, give $100 billion to hospitals and health providers, make $500 billion of forgivable loans to small businesses, states and municipalities, and more. In April they added $484 billion to the small business PPP forgivable loan program. As of July 31, the Republicans and Democrats appeared pretty far apart on the next round of stimulus[1]:

 

  1. Speculation – It seems retail traders have embraced the February/March market crash, opening accounts in droves and speculating like mad. Online brokers reported a dramatic spike in new accounts opened in the first quarter of 2020. Charles Schwab reported an increase of 58% over the first quarter of 2019, TD Ameritrade a 149% increase and E*Trade up 169%[2]. Stocks battered in Q1 2020 like airlines, cruise line stocks, and even bankrupt stocks like Hertz became retail favorites. Now stocks like Tesla, Apple, Eastman Kodak, and Amazon are among the new plats du jour. It seems that with sports mostly shut down, it appeared the stock market attracted a new audience of gamblers looking to play their hand on the markets instead of betting on the Super Bowl, World Series, March Madness and thousands of other cancelled sporting events. Their dramatic increase in account openings and massive buying spree has probably helped drive stock prices higher. We shall see if the opposite happens when selling starts. See our June piece entitled Day Trading Craze for more on this new wave of stock market gamblers.

  2. Forward Looking Market – While economic data is still weak and at recession/depression levels, there is hope and finger-crossing on Wall Street that we’ve bottomed out. Many metrics have reversed their February/March/April downward spiral and headed back in a more positive direction, meekly perhaps, but at least on the right course. For example, the U6 unemployment data referenced above peaked at 22.8% in April and was down to 18.0% in June. The wild card is, of course, the virus. It seems possible that another rampant outbreak could obliterate all shreds of hope and optimism once again, just as it did in February/March.

  3. Large Cap Tech Rally – The rally the past few months has been, for the most part, a big cap “tech rally.” Stocks like Amazon, Netflix, Apple, Microsoft, Tesla, Google (i.e., Alphabet), Facebook, Docusign, Nvidia, Zoom, and other big cap tech stocks have dominated the rally. Value stocks, small-caps, mid-caps, internationals, and others have participated, but to a lesser extent. We’ll talk more about this in our next piece on Coronavirus Era Portfolio Allocation Strategies.

  4. TINA (There Is No Alternative) – With cash yielding about zero, the ten-year treasury at 0.55%[3], and countries such as Switzerland, Denmark, Japan and others with negative interest rates, investors are having difficulty finding attractive investment alternatives to equities. Even though equities are typically more volatile than corporate and sovereign bonds, it appears many investors have concluded that equities are the more attractive alternative. 

 

BRINGING IT ALL TOGETHER

 

So, what do we take away from this mishmash of data, opinion, and information? Trying to figure out what the stock market is going to do next is a daunting task in the best of times and seems virtually impossible in these times. How much has the market been buoyed by the unprecedented levels of government intervention and trillions of dollars pumped into the economy by Congress and the Fed? We know these levels of stimulus cannot last forever. But one thing is certain: Had you bailed out of stocks in mid-March after the February/March 2020 crash, you would have missed out on the gains over the past four and a half months. One lesson is that sometimes it can be riskier to be out of the market than in the market.

 

Our conclusion is to be cautious, balance the reasons stocks could go higher against the risks that could push them lower.  Be aware that stocks can behave in counterintuitive ways and the price action doesn’t always move in a manner that seems logical.  This may be the perfect time to re-evaluate your objectives and risk-tolerance. Are you hoping to make meaningful withdrawals from your portfolio in the next few years?  Are your goals mostly fully funded at today’s values?  How did you feel when the S&P 500 was down 34% from mid-February to mid-March?  We recommend you sit down (or zoom) with your advisor and consider rebalancing and/or re-designing your portfolio to align your objectives with the inherent risks we currently face. You can watch this short video to get a feel for how we are meeting with clients in the Coronavirus era.  And stay tuned for our next piece, Coronavirus Era Portfolio Strategies.

[1] https://twitter.com/charliebilello/status/1222984325001596928.  For this assessment we are using the S&P 500 as a proxy for “the stock market” and declines in real GDP to gauge economic downturns.  Also, the generally accepted definition of a recession is two consecutive quarters of decline in the GDP.  The declines in real GDP shown in the chart may or may not be indicative of an actual recession as defined.

[2]https://www.bea.gov/data/gdp/gross-domestic-product

[3] Google Finance

[4]https://www.bea.gov/data/gdp/gross-domestic-product

[5] Bureau of Labor Statistics: https://www.bls.gov/news.release/empsit.t15.htm

[6] Google Finance

[7] Google Finance – as of 8/4/2020

[8] Google Finance

[9] New York Times and CRFB

[10]https://www.cnbc.com/2020/05/12/young-investors-pile-into-stocks-seeing-generational-buying-moment-instead-of-risk.html

[11]https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yieldYear&year=2020

Important Disclosures

Journey Advisory Group, LLC (“JAG”) is an SEC registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. This commentary is provided for general informational purposes only and should not be construed as personalized financial or investment advice.  Information has been obtained from sources deemed reliable but is not guaranteed. Securities and investing involve the risk of loss and past performance is no indication of future results. No strategy can assure a gain or the avoidance of loss. The opinions stated herein are those of the author and as of the date of this letter and are subject to change. The information contained within this commentary is compiled from sources JAG believes to be reliable, but we cannot guarantee accuracy. Any comparative indices shown are unmanaged and are provided as an indication of the performance of a given segment of the capital markets.  Indices cannot be invested in directly, and the returns shown do not reflect any fees, costs, or expenses.  Past performance should not be relied upon as an indicator of future performance. Forward looking comments necessarily involve known and unknown risks and are subject to change.  There can be no assurance that forward-looking statements will prove to be accurate, as future events could differ materially from those anticipated. We undertake no obligation to update forward-looking statements if circumstances or opinions should change. We provide this information with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas. For detailed information about our services and fees, please read our Form ADV Part 2A and Form ADV Part 3 (“Form CRS”), which can be found at https://www.advisorinfo.sec.gov or you can call us at 859-888-0355 to request a copy.

Definitions

S&P 500

The S&P 500 or Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The index is widely regarded as the best gauge of large-cap U.S. equities.

GDP

GDP stands for Gross Domestic Product which is the monetary value of all finished goods and services made within a country during a specific period.