The Market And Economy Continue To Diverge
Summary
- The stock market rally continues to defy deteriorating economic fundamentals.
- This is a function of Fed liquidity and misleading messages.
- The bullish thesis is based upon a robust economic recovery in the third quarter.
- That recovery is being undermined by ill-advised economic reopenings.
- This idea was discussed in more depth with members of my private investing community, The Portfolio Architect. Get started today »
The Divergence
I keep asking myself the same question each day when I look at the year-to-date return for the S&P 500, which is currently down approximately 10%. Are the revenues and profits of restaurants, malls, movie theaters, resorts, airlines, auto companies, retailers, cruise ships, amusement parks and every other business either directly or indirectly dependent on the consumer down also 10%? The answer is no. In fact, business revenues and profits are down much more than that and unlikely to return to pre-pandemic levels for years to come.
This explains why Warren Buffett didn't buy stocks after the 34% decline in the S&P 500 and continues to hoard $137 billion in cash. Of course, he will say "never bet against America," but all that means is he isn't willing to short stocks. It doesn't mean he is going to buy them anytime soon, so don't misconstrue his eternal optimism for the country as bullish. He isn't putting his money where his mouth is yet.
Technology companies that have capitalized on the stay-at-home and work-at-home trends, in addition to healthcare companies that are involved in battling the pandemic, have fueled the Nasdaq's recovery. Those two sectors account for two-thirds of index profits. Yet if those pandemic trends are about to end on the basis that the economy is recovering, we should be seeing a rotation in sector leadership, but we are not.
After cratering 30% from its February 19 all-time high, the Nasdaq has now rallied back 31%. Yet this is not all that unusual. The same pattern played out in 2000 when the Nasdaq Composite collapsed 40% and rebounded 42%, which was then followed by another decline of 43% over the following four months. That rebound was as confounding as this one is today. The difference for me is that I was a perma-bull in 2000, reinvigorated by the rapid price recovery and ignorant of the macroeconomic headwinds that lay ahead. I should have been using the rebound to reposition for tougher times. Instead, I doubled down on the shaky bets that fueled the markets all-time highs. Twenty years later I'm a lot smarter and more experienced than I was then.
Don't Be Fooled By The Fed
The market can trend in one direction on an idea or outlook that is completely baseless, defying all logic, for longer than the logical can possibly stand. I've seen this happen many times before, and it is happening again today. It makes us start to question reality and our well-thought-out investment thesis. The stock market isn't a reflection of reality from day-to-day, week-to-week, or even month-to-month. It is a perception of reality, which can often be wrong over short periods of time.
The greatest manipulator of that perception over the past decade has been the Federal Reserve, in its efforts to inflate financial asset prices. The Fed wants its market-manipulating efforts to translate into strengthening economic fundamentals, but it has repeatedly failed to succeed. Creating market conditions that influence investors to take more risk without also effecting a change in fundamentals is reckless. It is placing the cart in front of the horse. Regardless, the Fed has ramped up those efforts since the S&P 500 bottomed on March 23, leading to a bubble that is arguably bigger than the one it helped blow before.
As a result, misguided bulls are interpreting the rapid market recovery as an indication that the economic reality on the ground is improving. Every day they grasp at headlines in an attempt to explain, or better yet validate, the surge in stock prices from the day before. When I woke up this morning to a melt-up in stock futures, I read that it was because the U.S and China are making "good progress" on the phase-one trade deal. This is the deal that was baked into the stock market cake months ago, but now it is being recycled as good news. You can't be serious!
Yesterday's good news was that unemployment claims for the week were only 3.17 million, which is down significantly from the figures reported a few weeks ago. While I am a proponent of focusing on positive inflection points in the rate of change for economic statistics, this does not qualify as one. Still, bulls will keep grasping for straws to explain why the market is defying the reality on the ground until it finally relents. Meanwhile, the Fed will continue to do its best to levitate risk-asset prices in the hopes that fundamentals eventually support valuations, but rhetoric can only go so far. Additionally, despite trillions in quantitative easing over the past two years, the S&P 500 hasn't really gone anywhere. It looks like the tsunami of liqudity provided by the Fed is having an ever-lessening impact on financial asset prices.
The Bullish Thesis Is Being Undermined
Beyond the Fed's actions, the thesis that underpins this rally is that state reopenings will lead to a third-quarter rebound in economic growth, regardless of whether a second wave of coronavirus infections occurs or not. I disagree. I think the reopening efforts will fail miserably if the number of active Covid-19 cases climbs in the days and weeks ahead. The timing of these reopenings runs contrary to the President's own guidelines for Opening Up America Again.
We are now in the process of gradually reopening in more than 30 states, as if New York's success in flattening its curve has already been replicated in the rest of the country.
To the contrary, when we exclude New York from the map, the 7-day average of new cases in the rest of the country is continuing to rise. This is far from the President's established guideline of a 14-day downtrend.
The gamble being taken by elected officials puts a third-quarter recovery at risk. Economic reopenings do not guarantee that consumers will return to the shopping malls, but for those who do, it greatly increases the probability that the virus will spread. If the number of new cases outside of New York continues to rise after these efforts, consumers will further retrench, and the recession will be prolonged, putting a third-quarter recovery out of reach. We should know whether selling in May and staying away, as I advised at the beginning of the month, was good advice or not over the coming three weeks.
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This article was written by
Lawrence is the publisher of The Portfolio Architect. He has been managing portfolios for individual investors for 30 years, starting his career as a Financial Consultant in 1993 with Merrill Lynch and working in the same capacity for several other Wall Street firms before realizing his long-term goal of complete independence when he founded Fuller Asset Management. In addition to writing for Seeking Alpha, he is also a Leader on the new fintech platform at Follow.co.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The Portfolio Architect is published as an information service. Lawrence Fuller, the publisher, is also the Managing Director of Fuller Asset Management, a Registered Investment Advisor, which is unaffiliated with this Marketplace service. While this service includes opinions about buying, selling and holding a wide range of securities, the publisher is not acting as an investment adviser or providing advice or recommendations to any particular subscriber. Any investment recommended should be made only after consulting with your investment advisor or completing your own due diligence. There are risks involved with investing including loss of principal. Mr. Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals or the strategies discussed by will be met.
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Comments (134)
Trying to understand how it is causing stock market to go up??? Someone is taking the risk ...it is not the Fed. Like to understand who?
PDs buy stocks.
Markets go up while earnings plunge. Since trump wants to win in November, he will direct Fed to continue this through November.
Then we can all sit back and count our money as we hurtle towards 4 more years of chaos, corruption, cronyism and chicanery.
Nov 26, 2019. 07:19 PMLink
The FED has been doing what they are doing since 1913. Since 1945 the FED has had much more control of the whole world since the American currency became the dominant currency. Since 1976 when they decoupled the value of the dollar from gold altogether the FED has had even more power in influencing the financial system. This is why Ripley's says, believe it or not, follow the FED.
To me, we are right below a number of trigger points that start about 1-2% higher in the S&P. Other trigger points will come if there is a sustained move. The market hasn't been able to broach those levels yet, but it might and if it does you will lose money if you are short and you will lose the opportunity if you don't invest more.
Your job as an investor is to determine first whether we're in a bull or a bear and then to act accordingly, not to determine what is "right" or "wrong."
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