Part 2: Does the stock market reflect economic reality?
Last week I wrote that 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.”
I agreed with what John had to say, but when he said “violent”, I didn’t realize it was going to be in the next 5 days! It turned out to be a violent move that happened faster than even John could have imagined. I did rotate into some value stocks and my plan is to dollar cost average on the inevitable dip. Here are a few reasons why this rotation happened so fast.
The first reason is that the economists surveyed by the Wall Street Journal expected a job loss of 8.3 million in May. On Friday, The Labor Department reported that the U.S. instead added 2.5 million jobs in May. The jobs report was off by over 10 million jobs! How can economists be this wrong? In this day and age with computer simulations and AI you would think they could come within 1 million jobs. This proves that you can’t invest using any data that the economists are forecasting. I prefer listening to what CEO’s have to say about the economy. Last week Jamie Dimon of JPM said that things were not as bad as they seemed. He is much more in tune with the economy given that he sees the economic data in realtime.
The second reason why I believe markets rallied was that we went from a strict quarantine to thousands of people gathering at rallies. Many people were asking themselves that if thousands of people can gather together, then it should be safe to eat at a restaurant or go on vacation? The scenes out of Las Vegas also showed full casinos with no social distancing. Many people in this crowd were not even wearing masks and the casino was packed. They clearly didn’t care about catching Covid. I don’t want downplay the virus because we have seen an uptick in Covid cases and deaths nationally this week. And who knows if there will be a second wave because of the recent protests. The stock market could suddenly become concerned if cases begin to spike. For now, fear over the virus has been knocked off the front page, but it could return.
The third reason is that the Fed has forced investors to choose between earning less than 0.50% or seeking out a higher yielding equity investment. I’ve written about this challenge a few times and spoken to many of you that dividend paying equities offered a better risk reward than bonds. With the Fed flooding the market with liquidity and the treasury printing trillions of dollars, equity markets had the advantage. I can buy a safe short-term corporate bond that is supported by the Fed, but that yield is now down to 1.15%. Next in line is a long-term corporate bond fund (10 year duration) supported by the Fed and that yield is down to 2.44%. On the other hand, I can buy a dividend paying stock with an average yield of around 3%. We know the risk and volatility with holding an equity investment. The question is how much risk does this bond ETF have with the Fed backing it? Since the Fed started buying these corporate bond ETFs, the price has gone up almost everyday, so at this point there seems to be no risk. On a 1k point up day for the Dow, the textbook would say that interest rates would rise sharply. Well you can throw out those textbooks because that didn’t happen. Instead corporate bond yields also fell.
The final reason why I believe that the markets went higher was the unemployment rate is still 13%. The people out of work for no fault of their own still need financial help. There is another $3 trillion on its way and if it’s anything like the other $2.2 trillion in stimulus, some of that money will find its way into the stock market. My hope is that markets become more stable and recent gains are consolidated, but something tells me that the year 2020 still has a few more surprises for us.
The good news this week was Bank of America announced that it is making a $1 billion, four-year commitment of additional support to help local communities address economic and racial inequality accelerated by a global pandemic. Other companies have also given support to help and I expect that this trend will continue. There could be less focus on the bottom line and more businesses focusing on having a positive impact on the well-being of the communities they serve. There is no better investment than investing in a growing company that is also socially responsibility. The textbook is also wrong about only profits being important to a stock price. Socially responsible investments are trading at a premium in this market. Bank of America’s stock price could actually trade higher for giving away $1 billion in profits. More investors seem to care a little less about profits and more about socially responsible investments. Let’s hope this trend continues.
