The stock market is not the economy
Over the past five months, investors have been exuberant, relieved, or perplexed by the resilience of the stock market in the face of unprecedented economic challenges. Americans have long relied on the stock market as a proxy for the US economy. Today, experts are quick to point out that the stock market is not the economy. Sometimes, investors bet in anticipation of economic recovery before it actually begins.
Fiscal and monetary stimulus
Was the negative outlook in March too pessimistic? We don't think so. Ranked by assets, the magnitude of bankruptcies has surpassed 2008. Small businesses on Main Street remain susceptible to business closures.
The Federal Reserve Board’s injection of trillions of dollars into the economy has been key. Global central banks hope that more money circulating means more economic activity. It can also mean more money flowing into assets like stocks and bonds. For the first time ever, the Fed has been buying corporate bonds, including junk bonds, helping even weak companies stay afloat. The Fed’s low interest rate policy encourages investors to chase bigger returns, and stocks have been just about the only investments yielding decent returns the last several years.
Rising Risks
With the stock market recovering ahead of the economy, risks for investors are rising. When will a safe COVID-19 vaccine be available? When will business travel return? Can Congress keep the economy afloat with additional fiscal stimulus? How will the US Presidential election impact things? If you could answer any of these questions, you'd have a big leg up but it's harder than ever to imagine what the world will look like 3-months, 6-months, or a year from now.
One near-term concern is the end of the enhanced unemployment benefit. On August 8th, President Trump used his authority through FEMA to replace the previous provision that gave out-of-work Americans an extra $600 per week in benefits, on top of state-administered pay, which expired at the end of July. Under the new order, the federal government would cover $300 in enhanced aid per person per week, and states have the option to match it with an additional $100. So far, only nine states have been approved by FEMA to secure the federal funds and only three states are kicking in the additional $100. This means most of the nearly 30 million Americans who are claiming unemployment benefits will see their benefit decrease from $985 per week to $385 per week, a 60% reduction.
Will the market care? By the end of June this year, the national debt in the United States had surpassed the gross domestic product. It seems that many countries are on track toward debt ratios above 100 percent, and nobody cares. Either this is an evolution in the way investors, economists, and central bankers think about government debt. Or it works until it doesn't.
Back to Basics
The threat of corona virus has changed the way we behave both socially and as consumers. This unusual time of working remotely and avoiding shopping malls benefits certain industries while severely impairing others. If you're like me, you've been buying more food at the grocery store and eating out less. You're probably receiving more packages from FedEx and UPS. Food, logistics, and healthcare companies are doing well. And the technology sector is strong with companies like Zoom, Microsoft, and Amazon thriving. On the other side, there's travel, hotels, and retail. Fine dining is in trouble. When will you go to a concert or movie theater?
We do not believe in buying bankrupt companies like Hertz or beaten down cruise lines. While some of these could be good long-term investments, they're also a short-term gamble. We have returned to basics. Today, we not only want to own companies with attractive earnings prospects as we always have, but we must focus on companies that are likely to succeed no matter what shape the recovery takes. That said, we don't see storm clouds on the horizon. For the time being, liquidity trumps risks.
Photo by Kelly Sikkema on Unsplash
What are your thoughts on the stock market and potential risks?
