Divergence
At its low point not four weeks ago, the stock market’s 35% decline from its high was the fastest on record. It’s no surprise a bounce followed. We commented on that possibility while stocks were in free fall.
Moreover, stocks anticipate the future, so it’s no surprise stocks continued upward as glimmers of hope hinted at a bend in the curve of growth in the disease. Before that inflection, we suggested markets would keenly focus on that data point and might turn up first in anticipation.
A few weeks ago, as panic dominated, prospective long-term stock returns improved substantially. Then massive fiscal stimulus arrived to blunt the edge of the self-inflicted recession and massive monetary actions freed some freezing markets and mitigated the worst-case scenario. The large rally in stocks in response coupled with deteriorating near-term fundamentals and a murkier longer-term fundamental outlook have combined to remove some of the valuation advantage in stocks that had earlier built up.
As this is written Friday morning, the Russell 3000 broad Index of US stocks has jumped 27% from recent lows and sits only 14% below where it started the year, reversing about half of the market’s decline. Rapid and unprecedented monetary policy response should be expected to have a larger impact on financial markets than on the economy, so some divergence between markets and the economy is expected, but, while we welcome market progress, the size and speed of this bounce gives us pause and we wonder if now the bounce itself may also be somewhat overdone.
Overarching all is the health crisis, and developments there are mixed. On the one hand, many believe we may have just passed the peak in new cases in the US. On the other hand, there remains as much uncertainty as ever about how rapidly the disease may dissipate, and about when and how the phased Great Reopening may occur under just announced guidelines. How do we express this prudent caution? In accounts where the rally pushed stock allocations above targets, we are rebalancing by selling stocks to those targets when tax conditions allow. In accounts where stock allocations remain below targets, we continue to buy, but not all the way to target allocations. In all cases, substantial divergence in performance among sectors and individual securities has created significant opportunities to adjust holdings to improve prospects and to harvest tax benefits.
Headlines
The economic data is horrendous and likely to get worse. Journalists pass it on breathlessly and with an air of great importance, as if crying “Fire!” in the theater were somehow a great service. Most of this is best ignored. Ominous comparisons to the Great Depression? No, this is nothing like that. “22 million unemployed, wiping out a decade of job gains!” No, every survey indicates 80% or more of those are only technically unemployed, furloughed to allow receipt of temporarily enhanced unemployment benefits, but with a job waiting on the other side when social distancing measures are eased.
20% or so of 22 million, however, is no trivial matter. We recently had about 130 million full-time workers in the US. 4.4 million newly unemployed from that is about 3.4%. Add that to February’s 3.5% unemployment rate, and we are suddenly at nearly 7%. That is bad, but it’s not the Second Great Depression.
Also, all the stark headlines are about the steepness, the severity and rapidity of the decline of various measures of the economy. That this sudden elective halt in economic activity is steep is already widely known. What remains unknown is its duration. When a financial journalist tells you that, it’s useful information.
Concluding
These are difficult times: tragic for many, challenging for all. As we seem to edge closer to the end of the most severe isolation measures, market volatility has eased yet stays relatively high, and market pain has been halved even as substantial uncertainties persist. That makes us a bit more cautious on markets generally, yet dispersion has created selective but significant opportunities.