Month: June 2020

What’s Moving the Market: Explained in Three Graphs – Part 1 

The pandemic shuts down the economy … and the stock market goes up.  People are rioting in the streets to protest racial injustice … and the stock market goes up.  The United States threatens to strip Hong Kong from special trade status, potentially reigniting trade wars with China … and the stock market goes up.  The rise in the general stock market seems at odds with the economic data being reported.  Granted, the market is supposedly a measure of future results, not current results.  But then how does one explain the market’s strength at the same time that management teams and analysts are racing to lower earnings and cash flow projections? The following three charts perhaps offer some explanation.

 

 

Personal income is up.    Personal income in the US surged 10.5% in April, the biggest jump since the US Bureau of Economic Analysis started compiling data in 1959.  Disposable income rose by 12.9%.  The increase is largely due to an increase in government spending.  Government social benefits accounted for $6.3 billion, or 30% of the personal income in April, almost twice the normal percentage.  One can debate the merits of the government bailout, but the impact is clear.  Government spending has put additional dollars into the hands of consumers.  However, consumers are not spending the increase in income, instead choosing to save it.

 

People are saving, and there is nowhere else to put
money.  People have responded to COVID-19 concerns by staying at home, which has reduced the money they spend on entertainment.  They are also foregoing other discretionary spending due to employment and economic concerns.  The personal savings rate has skyrocketed to historic levels.  The personal savings rate is a measure of savings as a percent of disposable income.  Brian Moynihan, CEO of Bank of America, tells CNBC that checking accounts have 30% to 40% more money in them than 12 weeks ago.  This comes despite historically low-interest rates.  Put plainly; the money must go somewhere, so why not the stock market?  And why not put those dollars in stock that are well known?

 

 

The stock market has become dominated by a handful of tech stocks.  Since bottoming out on March 17, most major indices are up approximately 20%.  Information Technology stocks have led the push with the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) up more than 30%.  Technology stocks are less affected by a reduction in consumer spending due to COVID-19 or racial tension.  In fact, Apple and Google could become major players in the fight against the virus through contact tracing apps, while Facebook and Netflix are seeing increased usage, and Amazon is benefiting from increased home deliveries.  Major stock indices such as the S&P 500 or the Russell 200 are meant to measure the performance of a broad group of stocks comprising all aspects of the economy.  In actuality, the performance of the indices is heavily influenced by a small handful of large companies.  Amazingly, five stocks (Apple, Microsoft, Amazon, Google, and Facebook) now comprise 18% of the S&P 500’s market capitalization, roughly equal to the market weight of the bottom 300 companies.  This percentage has grown steadily in the last ten years.  The strong performance by the stock market, then, does not necessarily reflect improving economic conditions but rather that of just one sector or maybe even only a handful of companies. 

Suggested Reading:

Small-Cap vs. Large-Cap Investing

Should Economic Aid Target Business or Individuals and Families?

Should the Stock Market be up Double-Digits on the Year

 

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Sources:

https://www.cnbc.com/2020/05/29/us-savings-rate-hits-record-33percent-as-coronavirus-causes-americans-to-stockpile-cash-curb-spending.html, Maggie Fitzgerald, CNBC, May 29, 2020.

https://finance.yahoo.com/news/looting-protests-and-covid-19-havent-pounded-the-stock-market-160426990.html, Brian Sozzi, Yahoo Finance, June 2, 2020

https://finance.yahoo.com/news/5-powerful-tech-companies-now-make-up-18-of-the-stock-market-heres-why-this-could-be-a-bad-thing-145710881.html, Brian Sozzi, Yahoo Finance, February 3, 2020

https://qz.com/1862614/personal-income-in-the-us-shot-up-a-record-10-5-percent-in-april/, Karen Ho, Quartz, May 29, 2020

http://arnerichmassena.com/blog/faang-phenomenon-sustainable/, Jillian Perkins, Arnerich Massena, June 29, 2018

https://www.yahoo.com/news/faang-stocks-defying-coronavirus-bloodbath-115111875.html, Ritujay Ghosh, Zacks, May 26, 2020

 

How High Can the Market Go?

The markets continued to defy gravity after NASA, with the help of Zoom, rang the Nasdaq opening bell from space on Tuesday, June 3.  The major indexes have continued to reach higher each day since the March 23^rd bottom, causing some to feel uncomfortable with the current level of the market. Nasdaq has been particularly ballistic. In just under six months this year, the Nasdaq 100 has gained 11.2%.

There are many economic, political, medical, and business concerns that would cause one to expect the market to be down. There are also various measures and valuation methods that suggest the most followed indexes are at their melting point. Rather than listing these concerns or rehashing the extreme valuations, it is helpful to understand the reason for the rise. In this way we are giving the market the benefit of the doubt. After all, successful investors know, the market is never wrong. To make money you must know where it is going, even if you don’t think it should go there.

 

The Sustainability
of Daily Market Increases

The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of U.S. consumer confidence levels conducted by the University of Michigan.  The current sentiment has not been this depressed in eight years. Obviously, with 14.7% now claiming unemployment, households are deciding which basic necessities they can afford and which they can put aside. For a large percentage of Americans, this makes discretionary spending out of the question.

With such a large population of consumers avoiding discretionary spending, corporate earnings will be squeezed in most sectors. Businesses already are going bankrupt at a record pace. Some of the more recognizable names that filed for bankruptcy in May included J. Crew, Neiman Marcus, Hertz, and Tuesday Morning. Airlines which had crew shortages in 2019 are laying off thousands this year.

Under even the best conditions, daily stock market increases are not sustainable. So it is safe to project they certainly will come to an end at some point. All rallies do. This latest rally has continued for three reasons. All three are positive expectations rather than actual experience.

1. Expectations of a quick cure and/or vaccine for Covid-19 will get us back to work
2. Expectations for built up post-pandemic demand will be highly stimulative
3. Expectations that Government financial support will be immense and ongoing

These three by themselves are likely just fuel for the current height of the financial markets. After all, at the beginning of this year companies were guiding expectations lower. Channelchek discussed this in an article titled Is
the Market Disregarding Earnings Results? which we published on February 14^th of this year. This was before the coronavirus lockdown and well before the riots that have spread out of Minneapolis. At that time it was easy to make an argument that markets were steamy and needed to cool off a bit. There are significantly more headwinds now, to say the least. Still, the Nasdaq 100 actually passed it’s February 19^th high in midday trading this week.

The University of Michigan also polls consumers on their expectations on improving business conditions. These numbers are quite positive. A higher percent of consumers than any time in the past ten years views the outlook as improving. This survey doesn’t ask “better than last year?”, it asks “better than now?” With this, it isn’t surprising that such a high percentage sees an improvement. Feeling that things will get better may have been the initial spark that stopped the fall in March.

University of Michigan Survey Data

Fear of Missing Out (FOMO)

The average daily growth in the S&P 500 over the past 50 days is 0.78%, while the return for owning a US Treasury 10-year for 365 days is 0.76%. That’s less than 1/365 in return. Risk versus return is one driver of investor behavior. Confidence is another driver. On the day after election day in 2016 the Dow hit an all-time after a dramatic late-day rally. Nothing had fundamentally changed in the market except increased confidence in business conditions. This stoked some buying which then prompted more buying.

It often only takes a couple of strong days before the attention of a larger pool of investors begins to want in on the rise in prices. This then feeds on itself as more and more see the movement and fear they will miss out. This happened when US stocks bottomed in March 2009. The economy was still bad and quite uncertain. The result, confidence in the future, and governmental support led to the longest bull market in American history.

Take-Away

There are some faint signs that the economy is bottoming. For instance, the number of unemployment claims has slowly declined, and mortgage applications, both refinancing and new purchases, are rising. Airline passenger activity and restaurant traffic are climbing as well.

The opposite of the fear of missing out is fear of staying at the party too long — not booking profits on the way up. This causes a downward movement that is often more rapid than the upward climb. The Fed and participants long the market certainly hope that after defying gravity amid so much uncertainty, that any reduction in pace leads to a soft landing.

                                                                     

Suggested Reading:

The
Feds ETF Purchases Will Impact Investors

The
Correlation Between Passive Investing and Underperformance

Can
the Market Continue to Defy Gravity?

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Sources:

University
of Michigan Data

https://www.nasdaq.com/articles/how-nasdaqs-opening-bell-defied-gravity-2020-06-03

Koyfin Market Data

Unemployment
BLS

Irrational
Exuberance, Chapter 8