Market Update

Back into the Black, Temporarily?

As of the start of this week, many of my clients were in the black for 2020 and nearly all the rest were down some single digit percentage for the year. That is due to good fund selection by focusing on funds favoring large growth companies, good timing on buying some beaten-down high-quality stocks and good stock selection on those purchases. It is also helped by diversification into non-stock market investments that did not go down nearly as much as did stocks, though they have not recovered as quickly either.

But, just as the S&P 500 index, a major barometer of large stocks, got back to breakeven for the year, we are starting to see some profit-taking. This should not surprise anyone. What is surprising is how fast that index erased a major downturn (known as a bear market). It took less than 60 days, by far the fastest stock market recovery from a bear market ever. Of course, the downturn was remarkably fast too.

Why has the Market Been so Strong?

So what has made the stock market go up so much since late March? It seems ironic that it should happen as unemployment numbers that were around 4% in February, soared to 14%, and by the Labor Department’s admission, if they had been correctly reported, would have shown 17% unemployment. Those are numbers you and I probably never thought we would see in our lifetime, numbers far worse than even 2008-2009, numbers that seem straight out of the Great Depression of the 1930s with its long soup lines, widespread bankruptcies and countless other woes.

The answer from many people is that the stock market is a forecaster, looking ahead at least 6-12 months and that it reacts to what investors believe will happen that far out. That may be part of the answer, but another major component is that the Federal Reserve has again flooded the world with newly created money, money it creates by buying bonds with its blank checkbook. That money goes to banks in a process that is mysterious to most investors, but it is the major reason, in my opinion, that the stock market went up so much after 2008 and has done so again in 2020.

That money is designed to be loaned by banks and spent by corporations and individuals to bolster the economy. But, when economic uncertainty is high and corporate chieftains are unwilling to spend, and when stocks are rising at the same time, much of that money finds it way into buying stocks and other investments. I am certainly not complaining, nor are clients.

Who’s Afraid of Debt?

At the same time, the U.S. Treasury is borrowing an additional $3 trillion dollars this year to pay for the stimulus packages passed so far, with talk of another package on the way. For perspective, the IRS collected $3.5 trillion in taxes last year while the federal government spent $4.4 trillion. Of course, tax revenues will be lower this year due to lower personal income and corporate profits, so that gap will widen a lot; then add to it however many trillions we eventually spend on stimulus with no revenue to pay for it. So, in one year, after essentially mandating a huge recession, the government in an attempt to soften the blow is going to spend somewhere between $7.5 and $10 trillion and probably collect less than $3 trillion.

Who Buys All This Debt?

Who buys all this debt? Most people think China, but that is far from correct. China is the U.S.’s largest creditor, but it only holds 5% of U.S. debt, according to Investopedia.

I’ve written this before, but the largest holder and buyer of U.S. debt by far is…wait for it…the U.S. government. Specifically, it is the Federal Reserve, once again bringing out that blank checkbook. As of May, the Fed owned nearly $7 trillion in U.S. government securities and it is buying more as fast as it can.

How long can this go on? As long as the Fed wants and the U.S. can afford to pay the interest on the debt. Don’t ever doubt that keeping that interest rate extremely low is a major reason why the Fed has promised to keep interest rates low. And even if the interest needing to be paid every year is skyrocketing, for the time being, other countries are doing the same thing and nobody seems concerned yet that spending far exceeds income. Don’t try this at home.

What’s Ahead?

States are unwinding their restrictions at an uneven and confusing pace depending mainly on the governor’s party affiliation, and people are coming back to formerly “non-essential” stores and jobs, hair salons (women are thanking God) and some restaurants. Flights are still 80% below capacity but on the way back up, and students are expecting to start school early in many places.

I do think there is a good bit of pent-up demand but that there are a lot of people who are going to take it slowly. And of course, 1/6 of workers have been without a job, though not totally without income. Not all of those will have jobs to come back to this year and that will certainly dampen consumer spending by quite a bit for the next few months and probably for a couple years or more. That’s why the best performing sectors of the market this year have been largely non-recessionary – tech, health care and energy (bouncing back from super-low oil prices.)

I do think the pullback today could be several percent for the overall market and double-digit percentages for the hottest stocks. We’ll have to see how things develop.