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Market Update – The World Turned Upside Down

Thomas BalisMay 13, 2020

Markets

Due to the ongoing Covid-19 crisis, stay at home orders have many Pennsylvanians spending more time, well, at home.  Whether it is gardening, home improvement projects, or just more time on Netflix or Spotify, many of us are seeking ways to keep busy and distract ourselves from the endless news cycle.  In our home, a family favorite is singling along to the soundtrack from Hamilton, complete with beeps substituting for some of the more colorful language unsuitable for our tween.  In one of the songs, the refrain repeats the phrase ‘the world turned upside down’, which seems an incredibly apt way of describing our current circumstances.  Record layoffs and unemployment, businesses shuttered, shortages of household goods, and a growing death count all contribute to a grim landscape.  Given this, many are asking how and why April was a record month for equity returns, and just as important, can the rally continue?

Source: Factset

Don’t Fight the Fed

Congress and the Federal Reserve have responded both quickly and massively to the economic crisis resulting from the forced shutdowns of large parts of the economy. Previously, it took Congress over a year from the market peak preceding the Global Financial Crisis to pass the Troubled Asset Relief Program (TARP).  In contrast, the CARES Act was passed mere weeks after the CDC warned of potential local outbreaks of Covid-19.  Moreover, the Federal Reserve moved quickly to provide nearly unlimited liquidity support to stabilize credit markets, making trillions available in partnership with the US Treasury.  The sheer scale and breadth of support has led some investors to believe that the market has already bottomed, driving institutional fund flows back into stocks.

It’s in the Price

The market decline from the February 19 record highs was sharp and sudden.  In less than five weeks, the market dropped over 30% as investors fled stocks for safer havens amid fears of recession and worse.  As Wall Street analysts began revising their estimates, consensus grew around the concept of a short-lived recession, with a clear recovery in late 2020/early 2021.  Markets are forward looking, with equity valuations being driven in large part by expectations of forward earnings growth.  April’s record stock rally in some ways reflects investor optimism that the economic impacts of Covid-19 will be shorter term, and that a rebound in earnings in 2021 deserves higher equity valuations than seen in March.  In other words, all the bad news may have already been ‘priced in’, which explains why the market kept rising despite millions more unemployed each week in the jobless claims data.

There Is No Alternative (TINA)

Another potential driver of the recovery in equities is commonly referred to as the ‘TINA Trade’ – There Is No Alternative.  The implication is that investors have to put their money somewhere, and that there is nowhere else to make money.  Cash is paying nothing.  Foreign bond yields are mostly negative. US Treasury yields are near record lows.  International stocks are trailing domestic stocks.  Some investors would say that US Large Cap stocks are the only game in town, and given the aforementioned federal response which has been much more robust than other parts of the world, the US is the best looking house in a bad neighborhood.  Moreover, the dividend yield for the S&P 500 is much more attractive than that of the ten year US Treasury.

Source: Factset

Blue Skies?

So, with all this, is it all blue skies and clear sailing from here?  Perhaps not, given all of the unknowns.  Some strategists see the market near the high end of the current trading range for equities.  Fears of secondary outbreaks, furloughs becoming permanent layoffs, and a return to increased international tensions are a few of the downside risks to the current recovery. Just because states begin to reopen economies does not guarantee that nervous consumers will immediately venture forth and spend money (although my need for a haircut is getting quite desperate.)

Fortunately, volatility, while still elevated, has declined sufficiently for HFA to rebalance most client portfolios, allowing us to buy equities ‘on sale’.  Moreover, the aforementioned factors, particularly Fed intervention, may continue to reduce volatility and bolster equity markets going into the summer, albeit with some potential rough patches along the way.  We have certainly appreciated the bounce back in April and May, but stand ready to take any other actions that may be appropriate based on economic or pandemic future issues that may arise.  Please do not hesitate to contact our office if you have any questions or concerns.