My article "The Coming Stock Market Crash - Smart Money Is Already Ringing The Death Bell" was by far my most successful piece on Seeking Alpha.
The reactions to the article showed a certain sentiment among Seeking Alpha readers, which was characterized by doubts about the diverging stock market and economic developments.
In this article, I want to address the latest developments in the stock markets and the possible implications for the future.
As always, I am completely unbiased here and do not want to take sides. I merely show how I perceive the world and how I make my investment decisions based.
After I first published the article "The Coming Stock Market Crash - Smart Money Is Already Ringing The Death Bell" exclusively on my TEV blog and then here, it became my most read article ever on Seeking Alpha. In the article, I pointed out how massively the net assets in so-called money market funds increased during the COVID-19 crash. Such funds are mainly used by institutional investors who try to remain as liquid as possible. While I did not want to call up a doom and gloom scenario or endorse the short side, I have expressed my skepticism as to the extent to which institutional investors supported the current stock market rally. Above all, I have pointed out that the market could currently experience a period of euphoria driven by greed and FOMO (fear of missing out) of many retail investors. Having said that, in this article, I want to address the latest developments in the stock markets and the possible implications for the future. As always, I am entirely unbiased here and do not want to take sides. I merely show how I perceive the world and how I make my investment decisions based on this.
Where we are now
Most recently, the trend has continued since April and has brought us rising equity indices worldwide. Here the v-shaped recovery of the stock markets contrasts with a somewhat stuttering economic revival, which can be seen in several aspects, which together form a very meaningful picture. The question remains, however, as to which investors are pumping all these billions and trillions into the stock markets and which investors are on the sidelines.
The real economy and stock markets live in two different worlds
I think all readers know the performance of the stock indices. Therefore, just to remind you, here is an overview that shows that we are close to or even significantly above the pre-COVID-19-Crash market phase, even though the coronavirus has pushed us into a severe recession (grey area).
Another aspect that stands out is how strongly investors invest their money in gold (and other precious metals). The price of gold has also marked recent highs, which means the following: We have a massive inflow of capital into equity markets and precious metals.
Things are entirely different in the world of the real economy, which slumped enormously. You can see how bad this recession is by looking at the following figures. GDP has plummeted, and unemployment rates have soared to historic levels.
The volume of transaction deals also fell sharply, which shows that companies are hesitant and are holding off on further investments and takeovers. As data shows, for example, the COVID-19 pandemic has taken a heavy toll on M&A dealmaking in the EMEA in the first half of the year:
- Aggregate deal value fell to EUR 266.6 billion in H1 2020 from EUR 371 billion in H1 2019 and EUR 345 billion in 2H19.
- Deal volumes collapsed to 2,619, a 35 percent decline from the 4,000+ transactions in both H1 2019 and 2H19.
- The European Commission has forecast an 8.7 percent contraction in the region's economy for 2020.
This will be no different in the American economy. Of course, we also have companies that have been able to perform extraordinary despite or even because of these difficult times (e.g., Apple (AAPL), Facebook (FB). However, if you take a broader perspective, it becomes clear that the COVID-19 crisis has destroyed an enormous amount of profits. Corporate earnings in the US are at levels last seen in 2015. And that level was before President Donald Trump's tax reform.
Some shimmers of hope in the sky
Besides, we have now seen more signs of hope. Job data in the US have recently turned out better than many had feared. The unemployment rate at the end of last week was 10.2 percent vs. 10.5 percent consensus and 11.1 percent the previous week. The unemployment rate in Canada has also fallen from 12 percent to 10 percent.
Besides, China has also reported strong growth again. While there is some doubt about the official figures, it is, of course, reasonable to assume that the reopening of the economy will also contribute to normalization and a return to growth. Since China was one of the first nations to impose a far-reaching lockdown, it is also apparent that the signs of a new economic upswing will be first to appear there.
There is also hope for the relatively rapid development of a vaccine, which could be available this year or at the beginning of next year at the latest.
Against the background of this good news, rising share prices can make sense. Investors are looking into the future, and with such a view, it is foreseeable, or at least possible, that the whole COVID-19 disaster could be over, and the world, companies, and economy could finally return to normal.
A lot of money is still on the sidelines
So if we summarize things, the real economy and the stock markets have moved enormously apart. But that is not unusual. Sometimes the economy chases the stock markets; sometimes, it's the other way around. But what doesn't quite fit the picture is the fact that an enormous amount of capital is still on the sidelines. We still have the same picture here that I described in my last article. The total net assets in money market funds have reached a plateau. As I explained in my previous article, money market funds are
managed with the aim of maintaining a highly stable asset base through liquid investments. These include cash securities and bonds with a term of less than 12 months. Although private retailers also have access, they are only a minority. The money market fund market is dominated by institutional investors, i.e. banks, insurance companies, and governments. Thus, players that have the most idea (or so they think).
We see here a lasting momentum that is still valid and should give food for thought. Over the last few years, the inflows into money market funds have increased more and more. When COVID-19 led to worldwide lockdowns, there was an additional shift of capital into money market funds, which correlated with the massive distortions on the stock markets since the end of February 2020. Hey, I know it will never be possible to prove the causality that exactly this additional capital in the money market funds was the capital that was created by stock sales in the stock markets. However, the correlation is impressive, and in my opinion, a very strong indication:
And if we now look at this long-term development, this trend is still valid intact. It is easy to see that capital inflows have ebbed since mid-May, but there have hardly been any outflows since then. The net assets still are above the USD 4,500 billion million levels and thus almost 1000 billion above the pre-COVID-19 levels. In the first week of August, net assets already rose again from USD 4,570 billion to USD 4,575 billion.
Source: Coming stock market crash? What smart money did so far (raw data: ICI)
A lot of money and hardly any inflation
Next, I would like to zoom out and leave the money market funds area and look at the current money supply overall. Here, too, the money supply (M3) has risen immensely since February (in the OECD).
Source: Organization for Economic Co-operation and Development, Monetary aggregates and their components: Broad money and components: M3: M3 for OECD - Total [OECDMABMM301IXOBSAM], retrieved from FRED, Federal Reserve Bank of St. Louis, August 9, 2020.
It is surprising to see this extreme money supply and liquidity in the market. What do all the investors, people, institutions, etc. want with this liquidity on which there is hardly any interest? No one can say for sure. It is also clear that they do not need to have much fear of inflation at present. The lack of inflation could reduce the incentive to invest money in equities. The recent fall in oil and energy prices, in particular, has kept the inflation rate low, or even lowered it further, despite the money supply.
Source: OECD (2020), Inflation (CPI) (indicator). doi: 10.1787/eee82e6e-en (Accessed on 09 August 2020)
Is the money on the sidelines smart money?
There is probably no answer to the question of what all that money is waiting for on the sidelines. However, we could perhaps answer this question indirectly if we knew who was standing there with all that liquidity in hand. I have already said that there are certainly signs that we are dealing with millennials who, out of boredom and certain greed, are pouring into the market and investing their money there, some of it at high risk. We currently live in a world where 13-year-olds are celebrated for having made several USD 10,000 on options. And we live in a world where stocks are rising, even though more and more institutional investors are withdrawing their money from companies. To this end, I took a look at particularly well-performing stocks and examined how institutional investors have behaved. It is noticeable that many of these high flyers had a high capital drain from institutional investors.
Source: Buy-side and sell-side bottom line per share based on CNN business data
I am aware of the weak spots of this consideration. Not all institutional investments in companies are always disclosed/gathered by CNN business. We are only looking at a snapshot, and of course, this is only a selection of stocks. Alibaba (BABA), for example, saw a positive capital inflow from institutional investors. And as I said before, I do not want to take any side or endorse a short call. However, I think that the overall picture at least indicates that the so-called smart money has been very cautious since the COVID-19 crash. Just a reminder: Also, Warren Buffett is still hesitant to touch his massive cash mountain and go on a significant hunt. Berkshire Hathaway (BRK.B, BRK.A) increased its cash pile in the Corona crisis to a record USD 146.6 billion. Share repurchases totaled USD 5.1 billion in the second quarter, almost double the previous record of USD 2.2 billion in the fourth quarter of 2019.
What will happen with all the cash waiting on the sideline?
All the liquidity that is still available plus the liquidity still to be expected from stimulus and aid programs could, of course, become a mega-catalyst for an extreme stock market rally. It could lead to greed and FOMO finally triumphing over smart money and all that money flowing into the stock markets. That's one scenario. Another scenario is that the shaky hands are currently mainly in the stocks and there primarily in the tech companies. It may well be that the available liquidity will, therefore, go to other sectors, which in turn could provoke an overall shift of capital from the tech sector to other industries. Perhaps the glimmers on the horizon turn out to be the glow of hellfire that has banished its way to the surface. Scenarios for this are conceivable. Perhaps there is no effective medicine or vaccine, after all. Maybe governments are starting to raise taxes massively to refinance the high expenditures during the COVID-19 crisis. In Germany, for example, a kind of a second Equalization of Burdens Act in the form of a one-off property tax for particularly rich people is being considered. Bernie Sanders' "Make Billionaires Pay Act" goes in the same direction. Such considerations show that we are living in times that are extreme for the economies, people, and governments, and it is not unthinkable that governments will take drastic measures to address the current circumstances. So there is a great deal of uncertainty overall and, accordingly, the question of how investors should react to it.
What my approach is
Some comments have accused me of being short or just angry because I didn't make any profits during the rally. Well, firstly, I do not want to endorse a pessimistic call or anything similar to that. Secondly, only because I observe certain things and write about them does not mean I'm on the sidelines either. I invest every week to increase my broadly diversified retirement portfolio (my investments in July), and I picked some nice companies as a bargain during that time (e.g., Leggett & Platt (LEG), Realty Income (O), Munich Re (OTCPK:MURGY) (OTCPK:MURGF) or TeamViewer (OTCPK:TMVWF)). Accordingly, I continue to invest in shares. The reason is relatively simple. I am incapable of timing the market. Already in May, I felt that a second COVID-19 crash was imminent and, oh my God, was I wrong so far. If I had listened to my feelings and sold, I would have missed a lot. While I always fail to time the market, I am a fan of facts. And historically, stocks brought the biggest return:
So the question is how I select the individual companies. Well, of course, everyone pursues his or her strategy. But the most important thing is that every investor must feel comfortable. I orientate myself towards Warren Buffett or rather towards a long-term planning and rational acting entrepreneur. I do not look at what the share price of my companies is, but how much cash I can expect from them in the form of profits or cash flows. Only then I look to determine whether the amount of cash flow is sufficient to justify the purchase price. Here is how Warren Buffett and Charlie Munger described this cash flow orientated approach:
The only reason for putting cash into any kind of investment now is because you expect to take cash out; not by selling it to somebody else because that's just a game of who beats who. [...] Investment is putting out money to get more money back later on from the asset and not by selling it to somebody else but by what the asset itself will produce.
Accordingly, dividends are a good first starting point for me (but I also invest in growth stocks that generate high cash flow and do not generate a dividend). For example, I mainly track dividend stocks and usually know the typical dividend yield of the companies that interest me. Every week I check which stocks are going ex-dividend and thus get a good overview of the current dividend yields and changes. Such an overview looks like this, for example:
|Company||Payment Date||Current Yield||In my retirement portfolio|
|Monday, August 10, 2020|
|Constellation Brands Inc. (STZ)||August 25, 2020||1.75%||NO|
|Skyworks Solutions Inc. (SWKS)||September 01, 2020||1.35%||NO|
|Hanesbrands Inc. (HBI)||September 01, 2020||4.2%||NO|
|Enterprise Bancorp Inc. (EBTC)||September 01, 2020||3.1%||NO|
|Papa John's (PZZA)||August 21, 2020||0.92%||NO|
|Tuesday, August 11, 2020|
|Southern Copper (SCCO)||August 25, 2020||3.03%||NO|
|American Water Works Company Inc. (AWK)||September 01, 2020||1.5%||NO|
|BankFinancial Corp. (BFIN)||August 28, 2020||5.2%||NO|
|Wednesday, August 12, 2020|
|Cambridge Bancorp (CATC)||August 27, 2020||3.8%||NO|
|Exxon Mobil (XOM)||September 10, 2020||7.9%||NO|
|Pool (POOL)||August 27, 2020||0.7%||NO|
|Thursday, August 13, 2020|
|Alliance Data Systems (ADS)||September 18, 2020||1.9%||NO|
|Visa Inc. (V)||September 01, 2020||0.6%||NO|
|Walmart (WMT)||September 09, 2020||1.67%||NO|
|AstraZeneca PLC (AZN)||September 14, 2020||2.49%||NO|
|Eli Lilly (LLY)||September 10, 2020||1.94%||NO|
|Royal Dutch Shell (NYSE:RDS.A)||September 21, 2020||4.1%||YES|
|Honeywell International (HON)||September 04, 2020||2.36%||NO|
|GlaxoSmithKline (GSK)||October 08, 2020||4.9%||YES|
|Raytheon Technologies (RTX)||September 10, 2020||3.17%||NO|
|Diageo (DEO)||October 14, 2020||2.63%||YES|
|BP P.L.C. (BP)||September 25, 2020||5.7%||NO|
|Enbridge (ENB)||September 01, 2020||6.96%||NO|
|Duke Energy (DUK)||September 16, 2020||4.58%||NO|
|Emerson Electric Company (EMR)||September 10, 2020||3%||NO|
|Eaton PLC (ETN)||August 28, 2020||3%||NO|
|MSCI (MSCI)||August 31, 2020||0.85%||NO|
|Kroger (KR)||September 01, 2020||2%||NO|
|Church & Dwight (CHD)||September 01, 2020||1%||NO|
|Corteva (CTVA)||September 15, 2020||2.05%||NO|
|Stanley Black & Decker (SWK)||September 15, 2020||1.81%||NO|
|International Paper Company (IP)||September 15, 2020||5.81%||NO|
|JM Smucker (SJM)||September 01, 2020||3.26%||NO|
|Friday, August 14, 2020|
|Amgen Inc. (AMGN)||September 08, 2020||2.65%||NO|
|Sabra Health Care REIT Inc. (SBRA)||August 31, 2020||7.94%||NO|
|American States Water Company (AWR)||September 01, 2020||1.75%||NO|
|Helmerich & Payne Inc. (HP)||August 31, 2020||5.36%||NO|
|Sabine Royalty Trust (SBR)||August 31, 2020||4%||NO|
Source: TEV's ex-dividend calendar
Often enough, I then notice opportunities for a good investment. It was the same now concerning Diageo. The company took a hard hit from the coronavirus. Revenue fell by 9 percent. Earnings also fell by 55 percent to GBP 1.41 billion. At last, the dividend has risen again somewhat due to the recent share price setbacks. As a long-term thinking investor, such developments are an excellent opportunity to get excellent companies at a lower price. Although Diageo is still slightly above fair value, the picture is much better than it was a few months ago.
Source: Fair value calculation Diageo
A different picture emerges at Walmart. The share has left the area of fair valuation far behind and would not be an investment case for me, although it is an excellently managed company. The cash flow to be expected for me is simply too low compared to the share price.
Source: Fair value calculation Walmart
Those who like such "shenanigans" could even consider taking profits at Walmart and switching to Diageo. Diageo is also likely to offer more value than Walmart for new investors. Diageo's dividend scoreboard looks as follows:
- Dividend Yield: 2.63%
- Pre-COVID-19 Payout Ratio Earnings: 53%
- Pre-COVID -19 Payout Ratio Cash: 62%
- 10 Year Yield on Cost: 5%
- Dividend Growth: 0 Years (Diageo increased only the interim dividend. The final dividend will remain at 42.47 pence per share).
On the other hand, while Walmart has a significantly lower yield, the dividend scoreboard looks similar:
- Dividend Yield: 1.67%
- Pre-COVID-19 Payout Ratio Earnings: 43%
- Pre-COVID -19 Payout Ratio Cash: 40%
- 10 Year Yield on Cost: 4.29%
- Dividend Growth: 47 Years.
- 5 Year Growth Rate (CAGR): 2%
In any case, this small excursion shows how I am currently investing despite the uncertainties and the feeling that the latest rally will not be supported by smart money and that we might have to expect some nasty distortions on the stock markets.
Even though there are some shimmers on the horizon, in my view, stock markets are still strongly decoupled from the real economy and that the so-called smart money sees it that way as well. Feelings, however, are the utterly wrong guide in investing. In the long term and statistically, equities are still the asset classes with the highest returns. I am continuing to invest accordingly. However, investors should not start to view investing as a race for the most gains. Gains are welcome, of course, but, as Warren Buffett said, that's just a game of who beats who and I do not play the greater fool game, and neither should you. Stay with quality, diversify, and enjoy the cash flow that companies generate quarter after quarter.
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Disclosure: I am/we are long FB, LEG, MURGY, AAPL, O. 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.