“Prediction is very difficult, especially about the future.” ― Niels Bohr
When John Bogle, the founder of Vanguard Group, first began in the financial services industry, he received the following advice that resonated with him throughout his career: “Nobody knows nothing”. The point being that it was impossible to know the future in normal times — and in precarious times like today, it is even more difficult. Everyone’s desire for certainty has been upended with the reality of a very unknowable future. After such a ferocious decline (see, the chart below) and what now has been an equally rapid advance, it helps to put fundamentals front and center when evaluating next steps.
Economic uncertainty is as great as it has been for decades, and forecasts by professionals are all over the map as to what the future holds. The dispersion of forecasts is so great as to provide almost no information for any relevant market analysis. A drop of 9% in GDP has no relationship to a drop of 50%. One is a deep recession, and one is a depression. See the charts below.
What market participants currently are doing is weighing the extreme liquidity pumped into the system by Federal Reserve Board and Jerome Powell’s resolve to “do whatever it takes” against the historic deterioration of economic data. The chart below shows both corporate stock earnings per share and Federal Reserve Bank of NY Weekly economic indicators plunging while the Fed grows its balance sheet to offset the damage.
The question investors must solve for: How deep and wide is the economic hole, and has the money thrown in been enough to fill it back up? There is currently a paucity of fundamental data, and the data we do have show an economy still decelerating.
“In March, the US LEI [Leading Economic Indicators] registered the largest decline in its 60-year history,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The unprecedented and sudden deterioration was broad based, with the largest negative contributions coming from initial claims for unemployment insurance and stock prices. The sharp drop in the LEI reflects the sudden halting in business activity as a result of the global pandemic and suggests the US economy will be facing a very deep contraction.”
Investors are flying relatively blind on the hopes of a vaccine, a treatment, and a relatively quick reopening of the economy without many hiccups. If that happens with only a six-month lapse in economic output, the market behavior we now are seeing is probably rational. If the economy takes longer to start, this is more akin to a bear market rally than the beginning of a new bull market. Turning the economy on will be more like using a dimmer switch rather than the flick of a light switch and will be slower to open than optimists are discussing. The market, however, looks ahead, and investors must judge how far is too far to gaze.
Complicating matters are market indices with very high concentration in just a few mega cap stocks, distorting the real picture of stock market discomfort most investors are feeling. Just five stocks, not unlike the internet bubble of the late 90s, are driving the majority of the gains right now. The Russell 3000 is an index comprising the 3,000 (2,957 currently) largest companies in the United States. The index is down -14.4% YTD, but the median stock in the index is down -32.3% as the mega cap stocks are the only companies being rewarded currently. Historically, when bull markets begin, the market broadens, and smaller and more volatile companies begin to lead as investors embrace the tint of a newly growing economy and the opportunity that follows. Right now, that is not the case.
Some of the technical conditions we laid out in our last writing are starting to fall into place:
- The VIX falling below 40 – Yes
- Credit Spreads contracting – Yes
- Yield Curve Spread (between 10-year and 2-year Treasury bonds) greater than 100 Basis Points – No
- Percentage of Stocks above 50-day Moving Average – No
Many technical signals suggest a market bottom, but often a retest of that low is necessary. That said, fundamentals warrant caution because a stock market cannot rise forever without an economy to underpin its flight eventually.
History shows that even if we are a bit late to reengage the market fully, being six months late is not too burdensome to one’s portfolio. As the chart below outlines, six months late to the new bull market is often more consistent and rewarding.
We know this period has been immensely challenging on many fronts. We reiterate that we are here, working diligently on your behalf for the long term. If at any time we can answer any questions or be of service, know we are here as your partner to traverse this path together.