It has been interesting to step back during the Covid-19 crisis and take a look at the various themes, or narratives, being promulgated by the popular, as well as the financial, press.
We know that the March market “crash” truly deserves the “crash” moniker as it was the fastest decline of 30% or more in history and the quickest ever move from a bull market high to a bear market (defined as a decline of 20% or more). With the pandemic getting worse every day and the economy experiencing an unprecedented shutdown, March was a very scary month indeed. While the virus news seems to be improving lately and the economy is creaking open somewhat, we know that we are likely not out of the woods though we hope and pray that we continue on the track toward putting this deadly virus in the rearview mirror, both medically and economically.
Three Recent Market Narratives
Switching back to the markets, it is interesting to look at some of the narratives heard lately in the press:
- Market has to retest the lows. The majority of market pundits have said that bear market bottoms tend to follow a particular pattern of breaking to new low prices, rallying off these lows, then eventually selling off back down to the previous lows. If the market “holds” – i.e. does not break meaningfully to new lows again – then it can rally into a new bull market. Ever since the March 23 sharp decline to a low followed by a bounce, the narrative was really strong to be careful as another decline was coming that may or may not hold at these March 23rd lows. To date, we have not experienced this predicted sell off and this narrative has slowly quieted down.
- Market is disconnected from the economy. This narrative has seemingly taken hold, in particular, with the popular press. In fact, on May 9, The Economist magazine had a scary cover stating “A Dangerous Gap – Markets v. the Real Economy”. (Some may note that magazines tend to have horrendously poor timing when putting market-related info on their covers. It’s been considered a contrarian indicator by some). The gist of the argument is we are experiencing economic numbers (declines) that are the worst in history, often surpassing the decline of the Great Depression. Yet, the markets are only around 15% off their all-time highs! The implied, or sometimes explicitly stated, message is that stocks are way under-reacting to the economy. Yet, most market followers know that:
- As horrific as these economic numbers have been, they are likely temporary, holding only as long as the economy stays shut down. Of course, that’s not to say things will snap back to pre-Covid levels in a matter of months, just that depression-like numbers will improve.
- Markets tend to react to future expectations, not current conditions. Invariably, markets bottom out months before recessions end. In fact, some of the best returns are often achieved in times of the highest unemployment, lowest GDP, and poorest earnings because ... the market has probably already reacted to the bad news prior to it being realized.
- A bubble is forming in the tech giants. It is true that the cap-weighted stock indexes have become very concentrated with the top companies such as Microsoft, Apple, Amazon, and Alphabet representing some of the highest cap-weightings since the dot-com bubble of 2000. Last month I wrote a bit about this concentration and some opportunities outside of big tech-company-driven, cap-weighted indexes. Yet, there is clearly economic justification for these companies to be the leaders. Not only have they excelled for many years, but they have also been particularly well situated to continue to perform well at a time when the world was forced to shelter-in-place. Nonetheless, while I don’t know about the likelihood of a bubble bursting, I do believe it is time for the laggards to catch up and outperform these fully-priced tech behemoths.
Narrative and the Long-Term Investor
So, the question is, what should a long-term investor do about the inevitable market narratives? The short answer is “nothing” – just continue to follow your long-term plan designed to help you achieve your cherished long-term goals. Continue to take advantage of the periods of heightened volatility to rebalance back to your predetermined allocation targets. This will automatically trigger trades that essentially “buy low” and “sell high”.
Ignoring narratives is the best strategy. However, I might point out that the three narratives I highlighted all implicitly argue that the market has to go down. If you have any interest in following the flow of market narratives, you might keep track of how many suggest buying is the right strategy vs. selling. It seems to be one-sided in favor of selling. Interestingly, the rationale for being bearish (expecting prices to go down) often sounds more intelligent than the rationale for being bullish (expecting prices to go up). Yet, quite simply, over time prices do tend to go up much more than they do go down. In fact, the inevitable long-term advance of the stock market is the best narrative of all!
