Based upon what I'm seeing on twitter, the financial media and anecdotally speaking to colleagues, there is a great sense of frustration and confusion about the refusal of the market to roll over. How in the blue hell can the market be down only about 15% from the all time high when we have all this massive economic damage? This is pretty much the question that is being asked. So what's the answer? Here are 2 possible explanations:
1) The market is forward looking and is pricing in a very sharp but short economic contraction because the threat of COVID has peaked and.authorities through their massive fiscal and monetary stimulus responses, will end up preventing a financial crisis and prolonged economic slump. Although there will be a massive drop in earnings, they should bounce back rather sharply as this was an induced recession as the result of an exogenous shock rather than an internal problem with the economy i.e. excesses/imbalances that need to be worked through. But what about the changes in consumer behavior in the post COVID world (i.e. social distancing, fear of traveling, ect)? Won't that be a major drag on the economy? The market may be saying this will not be a long term issue and since stocks are a claim on the cumulative cash flows of all future years, one write off year doesn't matter much as earnings will bounce back. Even if earnings don't bounce back to where they were prior to COVID right away, so long as they are not significantly impaired for several years, it shouldn't matter much especially in an ultra low interest rate environment where the alternatives will be beyond piss poor. Low inflation/interest rates makes the value of future cash flows worth more and right now interest rates are literally rock bottom.
2) The stock market is anticipating at least a temporary bounce back in activity and/or the rebound has been "sticky" because the market got very oversold in March and expectations got too low. There's been a shortage of sellers and an overabundance of bearish bets coupled with FOMO and technical buying. The more the market shrugs off bad news and embraces any glimmer of hope, the bolder FOMO/technical buyers get and the more frustrated and angry the bears get. Eventually we may get to the point where expectations notably rise and most of the FOMO/technical buyers are in the pool with bears having been wiped out. It's at that point when the market will be vulnerable to rolling over again, probably right about the time when the rebound in economic activity starts to fizzle out or the damage in earnings becomes too hard to ignore anymore.
The 2 above scenarios are not necessarily mutually exclusive. It could be that 2) plays out first i.e. a retest or minor break of the March lows at some point after we've seen the re-opening of the economy and the pent up demand bounce fizzles out, and then things stabilize and recover from there. I do realize that I'm making a lot of guesses here. I'm personally going to take the pragmatic, open minded approach and for now assume scenario 2 is in play now. That means that there's room for this market to advance further before the rebound is over, but I will not chase and I'll error on the side of caution. If it turns out that scenario 1) is indeed playing out I should hopefully be able to transition to that view as the evidence presents itself.
The thing that is most suspect about this rebound is how very narrow it has been. The tech sector is by far the largest contributor to the bounce with financials, small caps and value badly lagging. These were trends that were in place prior to COVID for years and they simply got amplified even more post COVID. We're seeing the resurgence of speculative activity like the action in stocks like TSLA and SHOP which is also not good. It's as if the bull market got resurrected and is in a zombie, hyper accentuated state of its former self.
No comments:
Post a Comment