Does the stock market reflect economic reality?
Yesterday I had a client sum it up well when she said that as a financial advisor I have both everything and nothing to do with politics. This was one of those weeks where everything seemed to do with politics. It’s always difficult to write about politics because of how polarizing it is, but it is undeniably having an influence on markets. The market sentiment has gotten much worse this week after George Floyd was murdered in broad daylight by a police officer and Minneapolis was engulfed in fire from rioting. Twitter also made an executive decision to suddenly fact check President Trump’s tweets, and Trump, in turn, signed an executive order targeting social media companies. The US and China relations have deteriorated to the point that free trade with China could be coming to end. On Friday, President Trump held a news conference on China, but he stopped short of terminating trade with China as many people had expected. The pandemic now has led to more than 100,000 deaths in the U.S. and 40 million claims have been filed for unemployment. The Chief Market Strategist at Baystate Wealth Management wrote, does the stock market reflect economic reality?
I prefer to focus much more on the part that has nothing to do with politics, which is following corporate earnings and business trends. If you focus on the current events and politics, you might put all of your money under the mattress. If you follow the pulse of the market, good news is good news, and even bad news is good news. With the hope of a vaccine by the end of the year and trillions in stimulus money floating around the system, and $3 trillion more on the way, there might be some extraordinary opportunities. Value stocks have continued their long period of underperformance against growth peers amid the Covid-19 market uncertainty. The Russell 1000 Growth Index is up 2.5% year-to-date, while its value counterpart is off 20%. I believe this is a trend worth following and I’m already seeing signs that a rotation is taking place into these dividend paying, value stocks which are beginning to outperform large cap growth.
John Rogers, co-CEO and chief investment officer of Ariel Investments, said on a recent call that value is extraordinarily cheap. “There are just extraordinary bargains there. I think it’s going to be a violent turn that will give value investors a great opportunity over the next decade.” David Herro, Harris Associates’ CIO, argued that the underperformance of value has scared away investors. “There’s so much underexposure to these businesses. I don’t know exactly what the catalyst will be – probably some view of the light at the end of the tunnel in terms of economic recovery. But when it does happen, I think it will be to value.”
The long-awaited rotation to value stocks may finally be coming, according to Evercore ISI. A combination of smooth re-openings, improving infection rates, high retail-investor cash levels and the historically extreme relationship between growth and value stocks all support conditions for a risk-on rotation in the next couple of months, strategist Dennis DeBusschere wrote in a note on Monday. The P/E spread between the top quintile of historical growth and traditional value stocks is extreme and investors need to be prepared for a violent move toward value if there is better-than-expected economic news or development of a vaccine.
The positive news this week for markets came from JP Morgan CEO Jamie Dimon speaking at the Deutsche Bank Global Financial Service conference. He surprised people when he said there is pretty good odds for a fast economic rebound. Banks may not need to build more loan loss reserves in the second half of 2020. He went on to say about a third of consumers requesting forbearance haven’t used it and he expects high repayment rates for those exiting forbearance. This economic crisis is much different than 2008. “It’s a healthier consumer,” he said. “You see that in underlying delinquencies. It’s completely different from a consumer standpoint” than during the financial crisis in 2008. However, Dimon did warn that a prolonged downturn is still possible, “If it does go on for a year, it won’t be very good,” he said. “You can’t prop up the stock market forever.”
I continue to expect volatility to remain high because of the fear around a second wave of the virus. The personal savings rate hit a historic 33% in April, the U.S. Bureau of Economic Analysis said Friday. As I wrote last week, time will tell if this pent up demand in savings will translate into Americans going out on a future shopping spree. There wasn’t much opportunity for many to go out out and spend money and now with the economy reopening, the hope is that the negative feedback loop will be broken and the stock market will begin to reflect economic reality.
