The weather is heating up and so is the market. The NASDAQ moved back into positive territory on the year while the rest of the major indices remain slightly lower. This shows the separation between the technology that now keeps us connected and the older in-person methods that we used pre-pandemic. This is what many have come to call the “New Normal”, a phrase that has taken on many meanings.
To start, we will address some social issues going on in the world today. As advisors, we do our best to remain unbiased towards social and political issues, and only address them in regards to their implications economically and financially. In Canada, the United States, and globally there has long existed a racial bias towards minorities that appears to be coming to the forefront now more than before even though the issue has existed for a long time and has been voiced throughout the years. This boiling point has created a lot of disruption and chaos and while this causes further conflict, disruption and chaos are what causes change. We look forward to a brighter future with more equality.
Going into June, we are still in quarantine, and people are still sitting at home without jobs, so why is the market recovering? While we are far from being in the clear it is important to point out why the market is moving higher. First off, stock prices are based on the potential for future earnings. This means the prices and fluctuations you see today are the recalculation of potential earnings into the future. This is also why we had one of the greatest sell-offs in history this year because every day the model had to be recalculated to show the projected level of earnings loss in the future. This event was a surprise to the majority of the world and required a quick reaction. As we now are on the other side of that reaction the stock market is projecting what the world could look like 3-9 months into the future. So what is driving the index higher?
1. COVID Progression. There are multiple areas where we are making progress in regards to COVID-19. Firstly, vaccines and treatments are showing positive signs, suggesting that in the future these will be available to combat future outbreaks. Also, social distancing has proven to effectively “flatten the curve” or reduce the rate of spread. At first, people feared the effectiveness of this tool but it appears it does have a predictable outcome now.
2. Economic Reopening. The above has given areas the confidence to start opening back up the economy. While this is happening slowly and people remain out of work, the stock market is not reflecting what this looks like today but what this looks like in the future. Currently, it is not predicting a return to the old normal but much further opening than we have today along with a good portion of job recovery.
3. Government Stimulus. There has been massive job loss all around the world as governments have imposed a mandatory shut down for much of their economy. To fill this gap they have injected cash to make up for that job loss. This created a major valley between the job level of pre-COVID and the job level of post-COVID. While this does not completely fill the valley to reduce the depth of that valley. The market is predicting the loss of business will be reduced because of the stimulus.
These factors are helping the stock markets recover and predicting that in the future we will be in a better economic position than today. Further progress on COVID and economic reopening will only drive in further up.
That seems very optimistic, but now let’s look at the reverse side and what has the ability to bring this market down.
1. COVID regression. Once again the top driver of the stock market is our future fight against COVID-19. Firstly, a regression of the effectiveness of vaccines and treatments for COVID-19, this would reduce our odds of getting back to work and staying at work. A “second-wave” or “re-acceleration” in the disease would bring back our one tried and true defense against the disease, isolation, and social distancing.
2. Economic Closing. If we were to reverse our opening and bring back extreme social distancing this would definitely give another rapid sell-off in the markets.
3. Less Government Stimulus. A “second wave” or prolonged shutdown would be a tough situation for the government because there is a realistic limit to what governments can pump into the system. There are many countries that cannot afford a second round of stimulus due to a longer shutdown, this would create a longer and deeper valley of economic damage.
As you can see the data emerging every day, it is driving the markets up and down depending on this progress. New data by far is the leading indicator of what’s driving the movement in the markets. But, with the markets moving up it shows that there is a lot more optimism as we are making more progress than regression.
Personally, we can’t wait for a day when we can focus back on regular company fundamentals rather than predicting when and at what percentage a company will reopen its doors. However, this is exactly why the technology sector is rallying because they are the ones that have seen the smallest decrease in shutdowns and in some cases have seen an increase in business.
There are also some secondary factors that are playing with the markets and at any other time in our history these headlines would be dominating the news and moving the markets on their own so we can’t discount their economic impact.
1. US/China Trade War. Trade war? That’s so last year… While this trade war took a brief pause, the US and China have still been going blow for blow but without the headlines. The US President has constantly criticized China for their handling of the disease and once again got on the forefront of the attack on Chinese tech. He is trying to cut Huawei from its chip suppliers and prevent US companies from working with them. In retaliation, the Chinese government is looking at targeting US companies (Apple, Cisco, Qualcomm, etc.) and adding them to the “unreliable entity list”, as well as suspending plane purchases from Boeing. To further this, the US Senate has just passed a bill that could potentially “delist” Chinese companies from the US stock exchanges if they do not comply with their auditing procedures. In the US’ defense, all other countries comply with this audit with the exception of China citing that it would divulge state secrets. This non-audit has allowed many companies to come onto US exchanges and present false earnings reports, in most recent history Luckin Coffee was just caught for false earnings reports and that took the stock from $50 to $1.
2. US Presidential Election. The election is still scheduled for November 3rd, 2020. Normally this would be all over the news but it has taken a backseat to everything else. Current President Trump and challenger Democrat Joe Biden will square off in for the presidency to cap a very action-packed year. Both remain particularly quiet to date, but we expect this to ramp up significantly over the summer. Election years usually create a very volatile stock market as certain sectors become battlegrounds for each party platform. It will be important to get more information on where they are going to attack to make the right investment decisions. Currently, Biden is ahead in most polls but as was Hilary 4 years ago, so nothing is safe.
3. Debt. Governments have shut down economies and in turn, have paid people to stay home. While it seems this money comes out of thin air, it does not however, and it comes with a price. We most likely will not feel this impact for years to come but rest assured this will have an impact in the future. There will need to be changes down the road to cover these expenses.
With the markets being driven up because of the gradual reopening’s. People are slowly going back to work, hotels are slowly being occupied and flights are being booked for trips later in the year. The road to recovery is not usually perfect, but right now we are very happy with being cautiously optimistic. We believe there still exists the opportunity in the public equity market, but special attention should be paid to balance sheets as some companies have taken on a lot of debt during this downturn. Because of the excess of debt in the world and low-interest rates, fixed income remains a difficult area to navigate through. Low-interest rates, economic stimulus is good for equities investments but also very good for commodities and real assets.
We continue to believe in a well-balanced portfolio with a complimentary mix of both public and private (alternatives) investments. Through the last couple of volatile months, our investment philosophy has had considerably less volatility than the market and we will continue to look for opportunities to strengthen your portfolio characteristics. We preach having a long-term plan when it comes to your financial well-being and we will be here to help guide you for years to come.
Konrad, Justin, and Merriel
More articles and information is available at www.lkwealth.ca
Source: BCA Research, Bloomberg, Reuters, Yahoo Finance, Trading Economics
Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.
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