Market vs Real Economy  I don't often say "please read" in the subject line of these emails. However, I feel what is being said here this week important enough for you to take a few minutes to digest. I've also added a very short reading assignment just below for you after reading this week's commentary. Don't worry, it's only a few pages and is taken from the pages of "The Economist" which is undoubtedly more well written than than my prose. You can read the article in PDF format byclicking here. Anyway, on to the commentary.
I’ll admit it: this market baffles me sometimes. Here we in the midst of an economic shut-down — unemployment has exploded; bankruptcies are popping up all over the place; profits are in the tank — yet this market charges higher. The question is, is the action healthy? Not if we look at earnings, which, according to JP Morgan are down over 47% on average for companies reporting.
It’s fine… markets are forward looking… the economy is about to turn back on and everything will go back to normal.
Umm, okay…. The question is 'What is normal?'
The economy might turn back on, but social distancing policies have become a real thing. And large parts of the economy will not be the same… especially restaurants and entertainment. As discussed in prior blogs, we’re at a resistance point technically. Markets have drifted sideways for the last few weeks as the 2950-ish range on the S&P500 has acted as a ceiling and has yet to close above or ‘beak out’ from this level.
If this market were to follow a more typical pattern from here, we’d expect a pull back to at least 2800 on the S&P500 or so (and more likely 2650ish). I use these vague levels because… frankly… this market is making up new rules as we go, fueled by mind-boggling Federal Reserve intervention and government stimulus. That rocket fuel has done a solid job stabilizing the bond markets and keeping hope in the economy. The Fed can keep buying bonds, but what happens next? How long can we pay people not to work?
Of course, these are rhetorical questions, but they do have a bearing on the stock market. For a season now, these markets have moved based on how the fight against Covid-19 has been going. That’s shifting though… it would seem reality is going to have to creep into this thing. The big unknown is whether or not all this new debt of Uncle Sam’s will have any unintended consequences.
Meanwhile, we will deal with our moment-to-moment day-by-day analysis. Like I said earlier, I don’t get it… this market has done what it sometimes does: prove the greatest possible number of people wrong at any given time. However, I do everything I can to remove my emotion from the decision-making process. That word, PROCESS is key. We use a process to determine investment strategy. Sometimes that means sell into a market that seems invincible and sometimes it means you hold your nose and buy. Currently, the process still has a few red lights which indicate holding cash in the near term may be better than taking risk. Since not all lights are flashing red, we are not holding 100% cash. We do own some stocks depending upon the level of risk with which one has indicated they are comfortable. The process isn’t perfect; none are. However, looking back over time it helped avoid many of the big down drafts and protected capital. It doesn’t promise to get in at the bottom and out at the top, nor do we. It does offer a strategy which removes emotion and guesswork form the equation. We will follow the process and hold our noses if we must, but not because of how we feel, but because it is what the process dictates.
Ultimately, longer term, we expect the economy and market to recover. However, it would be out of the norm for it to move back in a straight line. Bumps in the road are the norm and we should expect a few more before we put this one in the rearview mirror. My take – I still think this thing has run up a little too fast and we are trading on hope. I think we can (and probably will) move lower in this trend. What I hear from a lot of folks is desperation – as if they missed the bottom and somehow missed their chance on this thing. In the industry, we call it FOMO. Fear Of Missing Out. It can push prices to the stratosphere, occasionally to the point gravity must take over. Math, in my opinion, still matters. Typically, right about the time you throw it out and succumb to FOMO is when the market knows. At some point, math will matter again… then again, I don’t get this market, but that doesn’t matter.
Again, I encourage you to take a moment and read "The Economist" article by clicking here. Kind regards, 
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May 11, 2020
