I hear from so many relieved people that “The Market” has recovered. Ever since the Covid-19 related “shock to the stock market” and the resulting efforts by Central Banks and governments around the world, we have heard various views of what the eventual recovery would look like. Optimists touted a V shaped recovery (sharp down, quickly followed by a sharp recovery). Those touting more “realism” predicted a W shaped recovery (up and down based on the trend of the virus). As it turns out it, it appears we are in a K shaped recovery (Peter Atwater, an adjunct lecturer in the economics department at William & Mary, is credited for coining the “K-shape” theory). This K analogy refers to the notion that the rebound is unequal, some markets have shot up again (i.e. large technology companies), and others have fallen (i.e. small businesses).
Market “experts” have been at a loss to predict the path of any market recovery because, first of all, they had no way to predict the track of Covid-19 and second, because the economic response has been so unusual. The economic shock suffered by the world earlier this year was the biggest seen in generations but the same isn’t true of corporate earnings, at least if we look at big U.S. companies. Why do I say the economic response has been unpredictable and unusual?
- The Federal Reserve gave support to investors that they have never done in history (direct intervention – buying bonds in the open market).
- The US Federal reserve is on a track to “negative interest rates”, an anathema to them prior to this crisis.
- Though there are differences between the members, the G20 countries have provided significantly more fiscal stimulus than they did in 2008-2009 financial crisis.
- The “FAANGs’” (Facebook, Apple, Amazon, Netflix, Google) earnings have increased by 140% since the beginning of 2018 while the broader All Country World Index (MSCI ACWI) earnings are down 20%. The Fangs have increased sales about 80% (in 30 months!), while sales for world stocks as a whole are flat.
- The top 5 stocks in the S&P are up over 73% from the market lows, almost double the recovery of the other 495 companies.
So where are we headed now? What should we look forward to? First of all, an obvious tactic is to go with momentum and buy the large technology stocks like Netflix or Amazon or even Tesla that seem to be on a tear. But to quote Peter Atwater again: “When extreme inequity is this obvious and this widely applicable, we’ve reached the point where the arm and the leg of the K are more like alligator jaws, primed to snap closed. Talk about the perfect accompaniment to an extraordinary financial market peak. Even inequity has been taken to extreme excess.”
We at Yes Wealth are aware that when bank CDs only give you 1% for 5 years and a 10-year treasury bond gives you ½ of that, companies that you read about in the paper and whose stock “just seems to go up no matter what” are tempting. We believe there is a definite transfer of wealth from an old economy to the “new economy” driven by disruptive technologies. But the valuations of many of the more famous “growth stocks” in the US, China and developed markets are more extreme than even at the top of the tech bubble. How long will this trend continue? No one knows, but if the worst of the pandemics’ economic impact is in sight, with or without a vaccine, the lopsided winner vs loser chart will subside as we return to a more normal society. The travel industry (airlines, hotels, destinations) will recover, health care will be important and so will restaurants. As always, we will look for innovative ideas in both stocks and fixed income investments that generate growth while protecting your assets from outsized risks.