During a worldwide pandemic, government mandated lockdowns, record unemployment, political discord, social unrest, and murder hornets (remember these), does this equal the perfect time to invest? If the previous quarter is any indication, the answer is a resounding yes. The S&P 500 soared nearly 20% and ended the first half of the year down 4%. As the S&P 500 gained nearly 20% in the 2nd quarter, Covid-19 cases in the US rose from approximately 199,000 confirmed cases to 2,621,831 while deaths spiked from 4,216 to 120,152.
In previous communications we have discussed several reasons for the rise in equites from the lows in March. The driving force in the 2nd quarter rally was undoubtably the coordinated fiscal stimulus provided by the Cares Act and monetary stimulus provided by the Federal Reserve. A major component of the Cares Act is the forgivable PPP loans, which currently totals approximately $2.5 trillion. Concurrently, the Federal Reserve has been injecting liquidity (dollars) into the economy by expanding their balance sheet with bond purchases, including mortgage-backed securities, corporate bonds and even ETFs. The Federal Reserve’s balance sheet has increased by approximately $3 trillion. At the beginning of 2020, the market cap of the S&P 500 was $26.27 trillion. By the end of the 1st quarter, the market cap had fallen to $21.42 trillion, a decline of $4.85 trillion. At the end of the 2nd quarter, the market cap of the S&P 500 grew to $25.7 trillion, a rise of $4.28 trillion. The PPP loans represent $2.5 trillion and the expansion of the Fed balance sheet represents $3 trillion for a total of $5.5 trillion. Is it a coincidence that the rise in markets in relative terms is similar to the size of government intervention? I will let you come to you own conclusions.
In 2008, you may remember the controversial TARP program which essentially saved the economy. The TARP program by contrast was estimated to cost $700 billion but only $426 Billion was spent. $5.5 trillion is almost 13 times greater than the total cost of TARP. It should be noted that the Federal Reserve purchases assets, they are not simply spending money. The Federal reserve received back $441 billion from those purchases and provided profit to taxpayers of approximately $15 billion. If all of the $2.5 trillion in loans is forgiven, that is a cost, but like the TARP program, the $3.5 trillion spent by the FED will not go to $0. They are purchasing assets, and those assets may provide a positive return to taxpayers. In other words, those concerned with government spending should be concerned about the cost of monetary stimulus but may not need to be as concerned about fiscal stimulus, the expansion of the FED balance sheet.
There is a disconnect between Main Street and Wall Street. Much of this rally has been led by large cap growth. There is no index to measure the health of local small businesses, but the Russell Microcap Index, which remains down 11.21% YTD may provide insight about small business pain. The average market capitalization of the companies in the Microcap Index is approximately $460 million, so it is still not representative of Main Street, which is likely feeling the pain worse. The most well-known market indexes are all large cap driven; for example, the S&P500 has an average market cap of over $53 billion, hardy representative of main street. This dichotomy cannot continue forever, small businesses and the consumer drives the US economy but over the shorter term these discrepancies can occur.
A second disconnect is between for-profit financial media, social media, and likely outcomes. It is no secret that for-profit media needs eyeballs. Good news or “Everything is going to be OK” does nothing to move the ratings needle. Certainly, it is the job of the media to warn consumers about potential pitfalls and dangers, but many stories fail to examine not only what can go wrong but what potentially could go right. Even worse we have become a headline centric society and the more sensational the headline the more attention it gets. The consequences in equity markets tends to be massive swings in both market sentiment and equities themselves. There is no denying that the pandemic is bad, and there is no denying that the pandemic has hurt and will continue to hurt the economy, especially small businesses, but as of now the worst-case scenarios that were written as fact have not come to fruition. Bad news that isn’t as dismal as expected is good news. Google trends provides key word searches and rank the popularity of a keyword search term on a scale from 0 to 100. 0 translates to no interest, 100 ranks a peak in popularity. At the end of the 2nd quarter, the search term “depression” logged a score of 100. However, by June 30th, the popularity score dropped to 69 as measured over the previous 12 months. The only time over the last 12 months that the search term “depression” was less popular than June 30th was when it measured 63 on December 28th.
I was sent a Bloomberg News article which was originally published on May 13th, 2020. The article titled, “Wall Street Heavyweights Are Sounding the Alarm about Stocks” highlighted only the most negative views without presenting alternate scenarios. A person who read this article could easily conclude that the major “Wall Street Players” have exited the markets but this simply was not true. Maintaining a long-term perspective combined with a proven strategy will prove profitable over the long-term. Very rarely does market timing work over the long-term.
Reasons to be Optimistic:
- Covid-19 is bad but may not be as bad as expected thus a net positive. Treatments seem to be helping and expectations of a successful vaccine seem to be gaining.
- The economy was strong to begin the year and bank stress tests did not reveal immediate concerns.
- Remember there has been a combined $5.5 trillion in monetary and fiscal stimulus. If life gets back to normal quicker than expected, this stimulus will provide benefit and drive asset prices higher.
- No alternatives – Low yields in bonds and similar concerns about real estate leave very little alternatives for long-term investors.
Reasons to be Cautious:
- Covid-19- We are still dealing with something that we do not fully understand. With more testing being available, confirmed cases began to rise. Will deaths increase or begin to plateau and decline? When does a vaccine arrive and what kind of immunity does it provide?
- Interational Relations, Trade, & Tariffs – the U.S./China relationship appears to be growing more strained surrounding diplomacy and trade; tensions in the Middle East and Asia continue to increase; deglobalization is resulting in trade bouts and increasing tariffs around the globe
- Job Losses – as the pandemic and resulting economic slowdown continue, there is data showing that some “temporary” job losses are beginning to become more permanent with government unemployment assistance winding down at the end of July. Monitoring these permanent job losses and unemployment rate will be key in seeing how well the economy is recovering