Bulls vs. Bears
Many people are trying to rationalize the disconnect between the stock market and the economy. Why is the unemployment rate at 14.7% and last week the futures market was up over 1% every morning? The trading sentiment indicators are reaching a euphoric level and the economic data is flashing recession. The short answer to this question is there has never been so much stimulus money being pumped into the economy. There is even more talk about another $2 trillion in stimulus money coming.
I’d like to share another observation that hasn’t gained as much press. I’ve realized that many large investors have become very bearish while younger investors have never been so bullish. Younger investors have opened a record number of brokerage accounts in the last three months.
The more experienced investors that I follow have all turned negative in one way or another. Jamie Dimon, Mohamed El-Erian, Carl Icahn, and Larry Fink are all warning about lasting economic damage. All of them were incredibly bullish for the last few decades. They have a front row seat to the real-time economic data and understand the longer term implications of how the business landscaped has permanently changed.
The younger and more bullish investors care less about fundamentals and short-term valuations. They much prefer price momentum and high volatility. I wrote last week that Elon Musk warned his stock price was too high and now Tesla stock is 4% higher than when he gave the warning. Younger investors shrugged off the warning because they are attracted to the daily volatility and positive price momentum and the high level of short interest in Tesla’s stock. There is a strong correlation that the more negative headlines about Tesla, the higher the price goes. The same could be said about the stock market. The more negative the headlines for the economy, the higher the wall of worry that stocks climb.
Maybe the younger and more aggressive investors have it right and the short-term fundamentals don’t matter as long as the long-term fundamentals improve when the pandemic ends?
This week I was on a conference call with Mohamed El-Erian. He is the chief economic adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-chief investment officer (2007–2014). He is a columnist for Bloomberg and a contributing editor to the Financial Times. His opinion is similar to the other views of the business leaders that have become more negative on the economy. Here is what he had to say.
He said we are all out of our comfort zones. Actually way out of it. Things are not going to go back to the way things were before. We are all worried about health risks and have experienced some mental anguish. There are many difficult decisions ahead. We have to reopen the economy, but are likely to see a second wave of the virus. Companies are going to become risk-adverse and they will change their supply chains. He expects companies will become less productive and there will be more of a domestic bias. The demand side of the equation is the major question market. I would add that this is where the more aggressive investors might have it wrong. Will people emerge from quarantine more frugal or ready to spend?
Mohamed believes that the more aggressive investors are also not taking into account that when the pandemic ends we will be left with more debt in the system. Governments, households, and companies will adapt to the changing landscape with higher debt levels. The more aggressive investors believe that they are in a win-win situation. They are betting that the Fed will bail them out or the politicians will mail out more checks. The Fed is your best friend and will even buy stocks if markets go down. Mohamed went on to say that if the Fed is willing to buy a high yield junk bond ETF then they would buy stocks as well. He was shocked by this decision because they are picking winners and losers and taking on default risk. This will lead to a misallocation of resources because people will only buy what the Fed is supporting, which is exactly what is happening. The flows into the High Yield ETF (HYG) have never been higher. This would not have happened if the Fed didn’t release a statement that they could buy High Yield. The Fed hasn’t bought yet, but the ETF symbol HYG is now in record monthly inflows. I have to hand it to the Fed that this bluff helped to stabilize the corporate bond market.
Mohamed finished the call saying that the long-term outlook for employment will depend on the path of the coronavirus and how fast consumers open their wallets when the economy reopens. Your goal should be to survive with your health and mental well-being and stay in the game financially.
It will be interesting to see how this all plays out over the next few years. Will the bulls be right in their early call for a sharp economic recovery or will the business leaders be right with their call for many stops and starts in the months and years ahead. I’d guess that if you are older and closer to or in retirement you will agree with Mohamed and if you are younger you will agree more with the bulls. 🙂
