What in the World is Going on Here?

The economy just lost 30 million jobs over the past six weeks – an incomprehensible figure that likely understates the actual damage because of slow and archaic state processing. The White House warned that unemployment could reach 20% by June. Real GDP fell by an annualized 4.8% in Q1 and forecasts suggest annualized real GDP could contract by roughly 40% in Q2. Consumer spending – the lifeblood of the economy – suffered its worst monthly decline (-7.5%) since measurement of this metric began in 1959. The Federal Reserve Chairman described this economy as “the worst ever”.

Oh, and the stock market just enjoyed its best month in more than 30 years and its third best monthly return since World War II. Of course it did.

How does this make any sense? Have investors lost their minds? When is the stock market going to wake up and catch up with all this horrific data? Why are stocks going up when the economy is not getting better – it’s getting worse? Why not get out of stocks and wait until the stock market catches up with the economy? What in the world is going on here?

Do not despise if you have asked yourself one, some, or all of these questions over the past several weeks. Look, the stock market does not make sense at times. And that statement alone should be reason enough to avoid trying to “time the stock market”. But you should also appreciate that a lot of what happened in April does make sense. It makes a lot of sense if you step back and appreciate how the stock market works. It makes sense if investors embrace the truth that the stock market does not behave like they think it behaves.

So, let’s step back and collectively address all the questions above as one: Why did the stock market rally in April?

Reminder: The stock market already plummeted based on the dire forecasts. Remember March 2020? In a 23-day stretch that began in late February, the stock market plummeted by 34%, marking the fastest bear market ever. This happened – mind you – while the unemployment rate (3.5%) was at its lowest level since 1969 and while weekly unemployment claims were near their lowest level since the 1960’s. The first blip in the weekly unemployment claims – 3.3 million new claims – was reported on March 26, 3 days after the stock market reached its nadir and was already recovering. 

What’s that you say…the employment data was lagging and the stock was out in front of it? Exactly the point. The stock market sold off in anticipation of the lousy data that we would get in April and May and June and July. You know…the data that we actually got last month.     

Reminder: The stock market only cares about today’s data that reflects yesterday’s news if it impacts tomorrow’s outlook.

April was the best month for stocks in more than three decades because the dramatic uncertainty we faced in March became less uncertain in April. Uncertainty did not go away. It never does. It was just that the extreme range of possibilities we faced in March became less extreme. The curve flattened. Covid-19 cases did not go to zero but we also were not experiencing over 1,000,000 new cases a day – which was a real possibility in March. Suggesting that the stock market needs to catch up with the economy completely misses the point.

Reminder: The stock market reflects large publicly traded companies in many different industries making profits in many ways.

Are most companies impacted by Covid-19? Without a doubt. However, the impact of this pandemic is clearly different for Microsoft than for Delta Airlines. It is different for Amazon than it is for Gap. And the stock market eventually baked in the differentiated impact of this pandemic. So, while the stock market may have recovered some of the losses in aggregate, it is worthy of reminder that cruise line stocks are down 70-85% since the beginning of the year; that oil and gas companies are down 50-70%; and that most brick-and-mortar retailers and airlines are down 50-70%. This is to say that the stock market is behaving like it is supposed to behave – dramatically penalizing the companies that have been and will be most negatively impacted by the coronavirus – a reality that gets lost in the aggregate.

Reminder: Investors were panicked in March. They behaved like panicked people behave.

This is a blurb from the Golden Bell Financial investment commentary to clients on March 11^th:

“One underappreciated yet important item of note is that the selling during these past three weeks has been largely indiscriminate – a sign that investors aren’t being entirely rational.  Stocks of companies with less debt or better cash flow that should be better prepared to weather an economic storm have sold off more than the companies with heavy debt loads or weak balance sheets.  Most of the ugly selling days have been a sell-first, ask-questions-later environment where fear dominates and the institutional investors are just selling what they can get out of easily.  That creates opportunity for patient, long-term investors who are not forced to sell.“

It is hard to say how much of the recent recovery in stocks has simply been the result of the fear and panic subsiding but it is clearly a component of the recovery. That is how this tends to work – panic causes irrational selling where prices fall based on deteriorating fundamentals but they go below the intrinsic, fundamental value because of the fear. Eventually, the fear subsides and prices find their fundamental value. This is the stock market’s way of transferring wealth from individuals who wait on the sidelines “for things to calm down” to investors who stay disciplined.  Investing in the stock market is not a free lunch and it is the scary periods that provide the reward for the disciplined investors.  That reward just came really quickly this time.   

Reminder: The impact of monetary and fiscal stimulus cannot be overstated.

It is difficult for households to fully appreciate how monetary and fiscal stimulus impacts the economy because we are used to a reality where job loss or loss of income means that a family can’t spend as much, has borrowing sources cut off, and struggles to pay bills. That’s the reality a family faces. But in in an economy where the government can borrow more at extremely low rates or print more dollars to buy goods and stimulate demand, the household constraints don’t apply. The unprecedented levels of stimulus we have experienced since mid-March – both fiscal (Congress) and monetary (Federal Reserve) – are likely to have an enormous impact on the economy – a point that does not get anywhere near the attention it deserves from individual investors.

Many readers are now saying, “Yes, but all this borrowing and printing of trillions of dollars has a cost.” To be clear, it does. This is not a free lunch. What the current stimulus effectively does is pull forward future growth and future demand into the present resulting in higher stock prices today at the likely expense of tempered future economic growth and compressed returns (for not just stocks but also cash and real estate and bonds) over the next 10-20 years. In this case, consuming too much on Friday night doesn’t necessarily result in a terrible Saturday morning hangover – it more likely results in a sluggish week to follow.

Reminder: Relying on any “expert” predictions about the future is foolish.

This really does not address the initial question and seasoned clients are tired of hearing it. However, it is important to note: Save for some “market prognosticator” who publishes daily market predictions to his nine Twitter followers and who correctly called 14 of the past 1 bear markets, no economists or forecasters or equity strategists predicted the dramatic impact that Covid-19 would have on the economy and the stock market in March. In the same vein, no forecasters or equity strategists predicted the immediate and robust stock market recovery we would experience in April. Just another reminder of the value of forecasts.

Look, the stock market is unpredictable and sometimes confounding. If it was easily predictable and always made complete sense, long-term stock returns would look more like long-term cash returns. But all told, the stock market makes a lot more sense than investors give it credit for.