We’re in the midst of a pandemic, ~40M people are unemployed, there’s social unrest on the streets, there are tweet storms and live videos coming from every direction… yet the stock market is trading at an all time high. S&P 500 has erased it’s COVID losses and is back to same levels when we started the year.
Forecasting market trends have never been more challenging. In order for main street investors to get through this period, they have to go back to basics and focus on fundamentals.
To start, let’s look at key drivers of GDP. First is consumer spending. It makes up nearly 70% of US GDP. If you recall from your economics courses, the GDP equation is Y = C+I+G+(NX). Quick reminder: C is for consumption, I is for gross investment, G is for government investment, NX is for net exports. Since the US is primarily an importer, NX variable is typically negative.
So, why exactly is the stock market trending up now? There are a few reasons:
- Latest jobs report is promising
- We’ve likely already experienced the bottom
- Trust in the federal reserve
- Investors do not know where else to invest
Latest jobs report
Last Friday, June 5th, the US department of labor announced that the unemployment rate has fallen to 13.5%. The US added 2.5M jobs. The rate fell for the first time in weeks.
There’s no question that this is a sign of optimism in the short term and given the headline-driven nature of the market right now, it was bound to rally. S&P 500 rose 2%+, NASDAQ on track for record highs, DOW closed 800 points above previous day.
If you want to visualize the impact of COVID on the job market in one graph, it’s this from NYT.
Have we already experienced a bottom?
Probably. There’s high conviction that we experienced the bottom on March 23rd. Beyond reasons shared above, there are:
- Extreme measures of fiscal stimulus
- Reshoring happening from large, multinational companies that can increase gross investment (capital is cheap right now)
- People have been saving; consumer spending can spike as the country re-opens
On the opposite end, there are important issues that are lingering. To name a few: social unrest in the midst of election year, US vs. China trade deals are lagging, vaccine timeline still TBD, a potential second wave of spread in fall, and more.
But investors can look past all of these issues because…
… In The Fed we trust.
There isn’t much to say here except that Federal Reserve has the ability to turn anything bad into good. Fed chair, Jerome Powell captured it well in his speech ~3 weeks ago. If you prefer to watch instead, then here’s the link for that:
I’ll save you time. JP’s main point: we will do anything and everything in our power to make sure we come out of this downturn.
Investors have nowhere else to invest capital
There’s isn’t a ton of action in fixed income, commodities or really any other asset class. Cash is somewhat interesting because it provides buying power, but money markets are abysmal given reduction in fed funds rate. Equity markets get all of the love when other asset classes become uninteresting.
So, how does a main street investor navigate current market conditions? Go back to basics. Buffet has preached this for decades:
- Examine businesses, not markets
- Ignore the madness of crowds
- Disregard efficient market theorists (so-called experts play this game)
- Avoid timing the market
Above all, be disciplined. No one knows where the market is going, but if you invest in good businesses that you understand and believe in over a long enough time horizon, then you’ll reap the benefits.
Note: This essay has been written and published on June 9th. Notes and data referenced above is effective as of date of publication.