Investment Focus | Issue 11 | Bounce Back Quarter
Bounce Back Quarter
After such a severe contraction in the first quarter, the last three months were a breath of relief (all indices were up by double digits in Q2).
But if the economy is still far from a recovery, why has the market been so strong in the face of so much uncertainty? Tom Bradley from Steadyhand was ruminating on this question and believes it’s due to the following:
The Declines Were Overdone
The panic during the dark days of March was palpable. It may have been worse than anytime in my career. The sellers ruled the day and some of the down moves, in bonds and stocks, were mind blowing. It’s important to keep in mind that we’re measuring the rebound from these March lows, a starting point that was no more rational than the February highs.
The Market Looks Forward
The value of a company is derived from profits and dividends many years in the future. Short-term results have an impact, especially when losses are as large as they are right now, but it’s usually overestimated. Mr. Market cares more about the company’s strengths and relative position many years from now.
The Recovery Has Been Uneven
Despite a wide range of possibilities, investors are looking for certainty and are willing to pay a high price for it. Those who are running to safety are accepting yields that are well below inflation. Those who want companies that are sure to thrive during and after the lockdown are also paying up.
The U.S. market indexes have been driven by a narrow group of companies (mostly technology) that have seen their valuations expand significantly. Left behind are a slew of stocks that are still well below their 2019/2020 highs. A portfolio that’s broadly diversified by industry and company type may be less expensive than it was three months ago.
Rates, Rates, Rates
I saved the biggest factor for last. Everyone is talking about how we must adjust to the ‘post COVID’ economy but few are adjusting to lower interest rates. Rates have been low for some time but have gone even lower in face of a recession, and importantly, they’re expected to stay there.
This has a profound impact on the stock market. Lower interest rates translate into higher valuations.
One area Tom didn’t cover was Quantitative Easing by the Federal Reserve. This involves the Fed purchasing massive amounts of securities (stocks), bonds, and even ETFs (a first). This increases the money supply and encourages lending and investment by adding new money to the economy, providing a bridge for the economy while it recovers.
Source: CNN Business – Fear & Greed Index
The Bottom Line
The market will continue to be volatile. Ongoing economic uncertainty and anxiety about COVID-19, a resurgence of cases in the US, the November election, relations between US and China are the themes to watch.
We don’t know for sure what’s driving the stock market higher, but investing is not about predicting the future but rather building portfolios that are suitable for a variety of outcomes.
It’s easy to get myopic during times of volatility. We can be confident in our conviction, that 5 years from now, money invested today will prove to have been well invested. However, no one can be confident in how any portfolio will perform over the next 6 months. This is just a reminder to be aware of your time horizon.
For long-term strategic investors, this time represents opportunity; added risks await opportunistic investors seeking quick recovery returns.
About Dan Lambert
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