- The stock market is looking beyond the economic damage caused by the pandemic
- Consumer behavior is being tracked to monitor the anticipated economic recovery
- Timing the stock market has proven difficult. Some sophisticated investors have missed the rebound in stocks
- Remaining invested and optimizing portfolios has been a prudent strategy
A Tale of Two Markets
The title of Charles Dickens’ book, A Tale of Two Cities, came to mind recently when putting the stock market sell-off and ensuing recovery in perspective. Investor behavior went from fear to optimism seemingly overnight. The opening words of the book made me also think beyond the financial markets about how I and others (might) feel. “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair…”
Portfolio values have been largely mended and the economy is expected to recover over time as businesses reopen and people return to work. While this positive development may feel like “the spring of hope,” uncertainty surrounding COVID-19, social tensions, and the upcoming election cycle may also feel a little like the “winter of despair.” The aforementioned concerns may change from day to day, but our investment oversight and process will remain constant.
Epoch of Belief
Why has the stock market rebounded when economic numbers look so bad? Put simply, the stock market and the economy are not the same thing. Economic data is backward looking and reflects the value and “health” of the overall economy as it was weeks or months ago. Stocks represent ownership in businesses. The stock market is forward-looking and its value is based on the expected future profits of these businesses. In February, stock prices fell weeks before any negative economic data was officially released as investors believed that future corporate profits would be negatively impacted by shutting down the economy. Conversely, stock prices began to recover in advance of any actual positive economic data as investors anticipated a recovery in future corporate profits due to the re-opening of businesses. In a recent report, Schwab and Ned Davis Research showed that historically, stocks outperform their long-term return average of 10% when Unemployment is high, GDP is low and expected corporate earnings growth is low.
Uptick in Activity
Consumer behavior is being tracked by data points including Apple Maps, TSA screenings at airports, hotel occupancy, and restaurant bookings. In-person debit and credit card purchases are also being tracked by one major bank to determine if people are going into stores or ordering online. The uptick in activity has been positive for investor confidence helping to drive stock prices higher.
In our March commentary, we shared the following chart of stock market downturns from past events and recoveries 12 months later. I thought it would serve as a good reference to illustrate again that stocks can make strong recoveries quickly and that it is prudent to stay invested and keep allocations consistent with your risk tolerance and long-term investment plan. Timing the market can be difficult for many reasons, the least of which being that market recoveries can happen precisely when investors are most fearful.
The chart below illustrates how unusually brisk the current market recovery has occurred. Note how long it has taken some memorable downturns to reach bottom from the previous peak (Duration) and then recover those losses (Recovery Duration). The 2020 Coronavirus Pandemic is not yet concluded, but at the time of this writing, the S&P 500 stock index is within 5% of the all-time closing high reached on February 19, 2020. We are 0.2 years into the recovery duration since the March 23, 2020 market bottom (assuming that is the low).
The economic impact of COVID-19 has proven to be unprecedented and I suppose that Mr. Dickens could add “it was the most unusual of times” to his text if written today. His opening words portrayed feelings of both optimism and despair. If given the choice, I would choose optimism and bet on America. The swift recovery took even sophisticated investors by surprise and reinforced the notion that outthinking the market is an exercise in futility, especially in times of uncertainty. It was also a reminder to focus on what you can control. While quarantined in our homes, we were busy optimizing client accounts through tax-loss selling, adjusting risk, rebalancing stocks and bonds, replacing portfolio holdings, investing cash in the market, updating financial plans and in some cases, maintaining status quo. Financial and economic uncertainty can create stress and confusion. A sound long-term investment and financial plan remains our prudent guide. We are happy to be in it with you for the long haul.