Is the Market the Economy?
Throughout the duration of this crisis, we have done our best to keep you informed on the markets and your accounts. Our advisors, myself included, have been doing weekly market updates and we hope you have found them valuable. In order to keep you from getting inundated with information and in light of things starting to settle down, we are going to go away from weekly updates for now. As the situation changes and we feel our friends and clients would benefit from more frequent updates we will of course oblige.
It is all but certain that we are in a recession. The data is not out yet, but I would be very surprised if we are not in a recession. A recession is defined as two consecutive quarters of negative GDP growth. We all know that half the country was shut down for much of the first quarter and even more of the economy has been shut down for the second quarter.
The stock market is often used as a barometer for the economy and if we are in fact in a recession you might ask “Why is the market not down more?”. In my view, the market has rallied dramatically for three reasons since its March 23rd lows:
Expectations matter more than reality.
The market is forward-looking.
The Federal Reserve and Treasury are willing to do whatever Is necessary to stem the economic bleeding caused by Covid-19.
Before I tackle these three reasons one at a time, let’s look at what major asset classes have done since the March 23rd lows. Below is a chart showing ETFs invested in U.S Large Cap Stocks, U.S. Small-Cap Stocks, International Stocks, Emerging Market Stocks, and U.S. Aggregate Bonds.
So clearly there has been a rally led by U.S. Stocks. But why?
The first of my three reasons is expectations. I discussed this previously in the article Expectations Matter. In February, when the markets began to unravel, we knew very little about the virus. The U.S. was way behind the ball on testing and death toll projections were all over the place. Frankly, the market did not know what to expect therefore in my view the market priced in the worst-case scenario (high death rate and overrun health care system). As March began to progress we learned more about the virus, testing ramped up, and drastic actions were taken in the form of stay at home orders. Additionally, Congress and the Federal Reserve took drastic measures to stabilize markets. Towards the end of March, the market had more information and a shot of adrenaline in the form of stimulus and Fed administered liquidity. Now that the market had information it realized the “Expectation” of the worst-case scenario was not the likely case scenario and therefore responded positively.
The second reason I believe the market has rallied is that the market is forward-looking. Even though we are very likely in a recession, stocks can still rise. Why? The market is looking past the recession and into the second half of this year into next year. To understand this, look at it this way. During a recession revenue and earnings take a hit right? Coming out of the recession revenue and earnings begin to rise. The rising earnings and revenue means the companies producing those earnings will be worth more. The market knows this and rises in anticipation of the recovery. This has happened in many other recessionary periods and each of the last recessions
The Early 90s Recession
Recession ended March of 91’
S&P 500 Bottomed October of 90’
The Tech Bubble Recession
Recession Ended November of 01’
S&P 500 Bottomed September of 01’ (The S&P 500 experienced another downturn in 02’)
The Great Recession
Recession ended June of 2009
S&P 500 Bottomed in March of 2009
The third reason for the recent rally is due to Federal Reserve support. There has been a term among financial professionals for at least the past decade “Don’t Fight The Fed”. What it means is that if the Federal Reserve is going to inject money into the economy to pump it up even if you do not agree with the policy fighting the trend and missing out on the gains as a matter of principle is a fool's errand. In my view the recent actions and statements by the Fed indicate that they are willing to pull out all the tops to support the market for the duration of Covid fight. The chart below shows the Fed's balance sheet and as you can see it has ballooned. I believe this helps solidify my reasoning.
Truthfully I don’t know if the market should have rallied as much as it has but the reasons I lay out above should help explain why we are where we are. To be fair I don’t think we are completely out of the water yet. In my view, there are two things that can derail this market again. The first would be if the economic news that will be coming out in coming months is worse than anticipated. We know the GDP number is going to be bad. If it is significantly worse than expected, that could be cause for a repeat of March. The second and far more terrifying risk is that we open the economy back up and the virus makes a bad enough return that we have shut everything down again. This shutdown has been tough for many businesses but to go through it a second time would be utterly devastating and the economic consequences could reverberate for years. We know the virus will make a comeback in the fall but I do not think it is likely that it will cause states to shut down again. For the next wave, we will be better prepared, we are better informed, and will take more precautions.
View related content at the links below:
https://fsgmichigan.com/blog/market-update-reopening-the-economy
https://fsgmichigan.com/blog/market-update-oil-prices-the-other-market-story
https://fsgmichigan.com/blog/2020-first-quarter-market-update
https://fsgmichigan.com/blog/the-coronavirus-aid-relief-and-economic-security-act-cares-act
https://fsgmichigan.com/blog/market-update-march-27-2020
https://fsgmichigan.com/blog/what-is-my-advisor-doing-during-a-bear-market
https://fsgmichigan.com/blog/the-dos-and-donts-during-market-volatility
https://fsgmichigan.com/blog/the-anatomy-of-a-stock-market-crash
https://fsgmichigan.com/blog/coronavirus-chaos-thank-you-for-your-confidence
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written By Brice Carter