Stock Markets on Pace for Best Month in Nine Years
How well the stock market has done in the month of April so far, in the face of all the very dark clouds in the economic sky, have people scratching their heads.
When we look at the current economic picture, it sure looks like all bad news, all very bad news in fact.
Unemployment claims rose by another 4.4 million this week, and the total number of claims recently has the unemployment rate projected at a bone chilling 18.3%. This is a Great Depression type number, and a number that we haven’t even come close to since those very dark days of the 1930’s.
Our economy is shut down in a way that we have never seen even during the Great Depression, and while we can only guess how much of a hit our economic shutdowns have caused to it, the low estimates are plenty scary enough.
Earnings obviously take a big hit when so many companies have scaled down operations so much, even completely in some cases, and the stock market certainly pays close attention to earnings, especially when they fall off the table. We’re not even sure how far the fall will be yet as this is still going on, and at best, it will take some real time to heal once we open the doors fully, and no one really knows how far off that will be.
Those who try to value the stock market in reference to just near-term earnings, which is a big mistake that a great many make, already tended to believe that the market was “overvalued” by way of their metric before any of this, and they see it all the more so now, given the much lower earnings and earnings expectations in the midst of this economic crisis. Even mistaken beliefs can bring prices down if they influence investor behavior, so we have to count this effect among those which are placing downward pressure on stocks.
There are some sectors such as the hospitality industry that people are wondering how much longer it will take to get back to normal, and just opening the doors again doesn’t mean that the people will all come back. As long as we continue to encourage social distancing, and as long as people practice it or even feel uncomfortable about resuming the close proximity that a lot of things require to function normally, like flying, going to sporting events, or even eating in restaurants, this is going to continue to impact the economy, for quite a while longer perhaps.
There’s also the matter of inflows and outflows of capital in and out of stocks. With so many people out of work now and others underemployed, along with all the small business people who normally invest being in bad shape financially as well, this causes less money to be put into stocks and more money needing to be taken out, to make ends meet.
People are also more disposed to sell their stocks when they are worried, especially when there is so much uncertainty out there like there is now. Retail investors took more money out of the market in 2019 than they put in, but this was made up for and then some by stock buybacks. Companies aren’t buying back stock now either because they aren’t allowed or they not dare because they need to keep the cash on hand, and this takes away what has been a big impetus behind the moves up in price that we have enjoyed up until this crisis.
Stocks hate a lot of defaults, and while the default rate has been declining steadily since the last financial crisis, we’re in for a lot more now, perhaps a whole lot more. Companies are borrowing more and more now, and those who survive will have to reckon with this. There is particular concern in the oil business, and some predict we will lose up to half of our current oil companies in the U.S.
There are even some big ones like Occidental that may have their lives taken by this virus, and we also have to deal with the collapse of the oil market which gets worse each day as excess supply continues to pile up. The price of oil dropping like this is in itself a big threat to knock down stock prices, and seeing them fall this much this fast takes this negative into new territory.
We also need to deal with the very serious threat of Joe Biden becoming president, who is much less friendly to the stock market and the economy than Donald Trump. We may not have to worry about Bernie Sanders anymore, who was four-square against both, but Biden is two or three squares against it and will be chomping at the bit to raise taxes as soon as possible. We were fragile enough before this crisis and this threat isn’t one that will go away until Biden goes away, which means at least 4 years of pain.
There is another threat from Biden aside from his platform, worries that he may be heading toward age-related mental decline, and his behavior of late has been quite disturbing. The Democratic news outlets have kept this out of view, but the Republican ones are happy to show us this, to a degree that we may wonder whether he’s crossed the line too far already. If he is elected and continues to decline, a realistic possibility for a man his age and apparent condition, the prospects of a president in full blown dementia is a scary one indeed, and is a threat that is too real for our comfort.
Stock Prices Are Fashioned Not Just with an Eye to the Present
There are so many negatives with stocks and virtually no positives, save for one, which is the perception of long-term value at these prices. This is why we have seen markets go up so much over the last month in spite of all these negative influences, which have run the table right now if not for the fact that what is on the horizon matters a lot too.
This is where all the confusion arises from, from their looking at the economy and seeing it so sick, and then wonder how stocks could go up so much in the face of this, like the Nasdaq rising over 30% since late March with the skies so dark that the sun is nearly blotted out. This river runs deep, and even though we should know that stock prices cannot just be about the near term, our minds have been so conditioned to put so much weight on this that we just don’t know any better.
We don’t usually see stock prices and the near-term economic outlook diverge anywhere near this much, as the current situation is a highly unusual one to say the least. This is like a good boxer who has beaten all of his opponents over the last 10 years not losing what would be considered a fair fight now, but one with his hands tied behind his back where all he can do is try to take all those punches.
Our boxer still knows how to fight, and if we would only untie his hands, he’d be back to battling it out and would still do pretty good, even though we may worry about him getting a little out of shape from all the inactivity lately. When we bet on him though, we aren’t betting on the next fight but on the outcome of a much longer career, where, based upon his talent, it is likely that he will win a lot more fights than he loses and we will still make a lot of money from this long-term bet.
The duration of stock trades can last from a thousandth of a second to decades, and these durations affect the prices of stocks differently. We saw a fairly big drop on Thursday afternoon when the market learned that Gilead’s coronavirus drug trials aren’t going as well as we thought, which kicked in program trading action which drove us down quite a way pretty fast. When they were finished, we rebounded, and those selling programs still did pretty well and were mostly out when the rebound occurred, otherwise they would still keep us moving downward until they were finished.
The market moves up and down quite a bit in a typical day, even when the direction of the market is mostly one way or the other. Some trade these moves and are in and out of their positions many times every day, and on the other end of the scale, most investors don’t notice or care such things and even moves much bigger and more sustained, lasting days or even weeks.
An intraday trader doesn’t even care where the price of the stocks that they trade will be tomorrow, and investors generally don’t either. Tomorrow is beyond an intraday trader’s horizon, and the great majority would never hold a position overnight, while with investors, tomorrow is far too close as their horizon is much longer out.
It is the longer-term money that really drives the market longer-term, and that bears mentioning even though this is true by definition. If you are an intraday trader, you need to be looking at the intraday action, driven a lot by other traders mostly, whether human or especially what the computers are doing. If you are an investor, you need to look at not only what the other investors are doing, especially the funds who need to build positions over time, you also need to anticipate what they may do, as additional information to guide your decisions.
Investors are not faced with many decisions, very few in fact compared to traders, who decide all the time and may even need to keep their eyes on their screens at all times, and may not even be able to go to the bathroom or make a cup of coffee without either exiting or having a chart up on their phones or tablets to take with them.
There are many investors who will pay way too much attention to the market than they should and this applies not only to the market but to the economy as well. They may have no intention to sell for years and didn’t sell when the panic hit the market in February, but somehow they feel the need to be concerned about the potential for a pullback or any of the things that we have mentioned as bearish influences on the market right now, even with so many of them and so many big ones.
They even tend to think that the stock market tracks the economy somehow, and when they read the news or turn on the television they will see others who think that this is the way things should work, and if this isn’t correlating well now, this may be seen to suggest that this will converge more. It has converged away mysteriously, so it may converge toward this mess mysteriously as well presumably.
The Present May Look Dim, But the Future Still Looks Fairly Bright, and this Matters
The rebound that we have seen with stocks can only be explained by one thing, and this one thing has been a powerful enough force to trump everything else. Big investors are seeing prices higher well down the road, at a time where this virus will only be a memory, and this is the horizon that has tempted them. It’s not that the current situation is being outweighed by this, it just isn’t in focus at all with this view.
Anyone who thinks that stocks are only driven, or in some cases, even primarily driven by present economic conditions are seriously confused, and there is too much at stake for us to be among them. With the misalignment so extreme right now, this is a perfect time for us to take a step back and examine our beliefs and align them more with our own expected duration of holding our positions.
A lot of the discussion in the financial media falls prey to this mistake, and it is very important that we seek to think for ourselves and not just believe everything we read or see because a lot of it isn’t very sound. Even the most common things like valuing the market based upon near-term earnings is utterly foolish, simply because the value of stocks includes time periods quite a bit longer than just next quarter or even next year, and we mention this so much in our articles because it is so important that investors understand this.
While there is at least some truth in stocks being correlated to the economy, this economic view that it considers extends well beyond 2020, and if we believe that it is limited to this, this is where we get mixed up. With a broader view, the ones that funds not only take but must take due to trading limitations which forces them into needing to take a longer-term view, things still look pretty bullish, and considerably more bullish when we give back a third of what stocks were worth earlier in the year.
We saw pretty clearly how short-term fears can move markets a lot, when the panic about the coronavirus first really took hold, so it’s not that we want to just ignore these things, even as long-term investors. These events are pretty rare though, ones with potential to command the interest of investors, but from the sheer velocity of this move, this was not a pullback that was supported by the longer-term money at the time.
Eventually it was though, when it had gone down enough and a lot of the people disposed to run had already left, and this was the time where we saw this big money step up to the table, which we shared with you at the time.
This is what we really need to look at as investors, not just the moves in action but the reasoning behind it, when we hear fund managers tell us that they see a lot of value at a certain point. As we have moved up this much, this interest has waned of course, but the continued move upward over the last 4 weeks tells us a lot about where all this money is focused, and it’s not on any of this decidedly bad news in the nearer term.
The road to the future will continue to be challenged, and we will continue to vacillate between the more upbeat and the more downbeat as conditions unfold, but things are so bad on this front now that they can only get better. The risks are still there, but they are much more defined than when people were running for their lives from King Kong not so long ago.
It is not unreasonable to both feel uneasy about the near term and still feel good about the longer term, and if it is the longer term that you shoot for, you need to separate these two views and go with the one that aligns with yours.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
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