30th Jun 2020 by Helge Kostka

Main Street vs. Wall Street

Wall St

Main Street and Wall Street seem to have decoupled in the last few weeks. It appears that investors are ignoring any future negative financial impact of the COVID-19 pandemic.

 


They seem to expect global economies and corporate profits to return  to last year’s level (V-shaped recovery) and that a vaccine will be found before a new wave of infection hits. However, most of the recent economic data released paints a different picture, for example, unemployment is still at very high levels.

Risky assets had a rapid recovery
Returns of global equities and investment grade bonds are now positive for the first time since the start of March 2020 and high yield and emerging market debt have recovered much of their losses. 

Source: Morningstar, own calculations, data as at 22nd June 2020

From a behavioral angle, hope and greed have overcome fear. The most commonly quoted fear gauge, the VIX, has receded significantly from its March high:

Source: Yahoo.com, data as at 22 June 2020

Many people still suffer
Many people have lost their jobs over the course of the pandemic and its rapid spread across the world. In the US, unemployment has increased to record levels:

Source: US Bureau Labor of Statistics, data as at 01 May 2020

Some leading US economic indicators like The Purchasing Managers’ Index (PMI) have bounced back from recent lows, but a turn in US corporate profits has not yet been reported:

Source: U.S. Bureau of Economic Analysis, National income: Corporate profits before tax (without IVA and CCAdj), retrieved from Federal Reserve Bank of St. Louis, data as at 01 January 2020

For 2020 the Fed projects that US real GDP will shrink by 7.6% to -5.5%. Two months ago, the IMF urged governments tto provide further economic stimulus to avoid a steeper recession; both the European and US governments are in discussions to do just that.

Wall of Money
In March, the Fed went beyond decreasing interest rates and started buying assets on an unprecedented scale and scope. The Fed has continued to take significant actions. Only this month it announced that it is expanding its asset purchase program from buying exchange-traded funds of investment-grade bonds to purchasing individual bonds. Consequently, the below chart shows that its balance sheet has almost doubled to over $7tn.

Source: Federal Reserve Bank of St. Louis, data as at 17 June 2020

Equally remarkable, growth in U.S. M2, a broad measure of money supply, has been its strongest since the Federal Reserve’s records began in 1960. Such huge liquidity is trying to find good investments, and part of it supported the recent stock market rallies.

Source: Federal Reserve Bank of St. Louis, data as at 01 May 2020

Mr. Market: An expert in assessing the future
Mr. Market was introduced by Benjamin Graham in his book “The Intelligent Investor” published in 1949. Graham is often referred to as the “father of value investing” and was the teacher of Warren Buffet at Columbia University.

Mr. Market is always a step ahead of the economy, as he prices in future economic developments. Therefore, he reacts positively to news on government stimulus, low interest rates and other central bank actions, as well as progress on developing a vaccine against the COVID-19 virus, because all of these are positive for economies and future corporate profits. Therefore, it is fair to expect economic developments to become positive in the not too distant future. The big questions such as “when?” and “by how much?” may have different answers from what Mr. Market currently prices in, as Mr. Market cannot assess known unknowns. , equally, nor can anyone else. Mr. Market is also influenced by broad investor opinion and sentiment, as well as excess liquidity.

However, doubting whether Mr. Market is right and betting against him takes exceptional skill and expertise to successfully assess vast amounts of data. Many famous investment voices from Graham to Buffet, Bogle to Fama advise investors against trying to time the market, just as we advised our clients only three months ago not to give in to fear and sell equities. We now caution them not to follow feelings of “missing out” and buy into the recent rally, proactively increasing equity exposure. Instead, following Mr. Market within your current strategy should be the better approach, versus hoping to be lucky.

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