On March 29th, I published a note titled “It's Time For Investors To Go All In On Equities.” The note started off by listing four contrary facts regarding the market that went against ingrained thinking that was significant to a degree not witnessed since the 2009 lows. The four contrary facts were as follows:
1. This is not a bear market
2. Poor economic performance over the next few months doesn't necessarily equate to poor stock market performance
3. Far from being irrelevant and out of ammunition, the Fed is more relevant than ever
4. There is no historical reference to this market. It is completely unique and unprecedented in scope. Future results will reflect this fact.
Some 40 days later, after much reflection in the midst of a historic market rally, the ingrained nature of these thoughts is slowly dissipating, although not at the pace one would expect given the velocity of the upside.
We've learned that this isn't a bear market at all, as the Nasdaq is close to making an all-time high.
We've learned that poor economic data can cause shock and awe among the pundits while the market rallies.
We've learned that the Fed is indeed very relevant, as they literally rescued the economy from the brink of a catastrophic meltdown.
We are, however, yet to learn that there is no historic precedent for this market. This last point may be the most important as this year progresses. It's a point I want to focus on briefly here, as understanding this single fact may be the difference between a good and great year in the portfolios of investors.
Over the past few months all of us have grown exhausted of hearing the word unprecedented. In fact, if you look at trends in the media, the use of the word unprecedented has grown exponentially in recent months.
It should strike everyone as odd then when investors and analysts pull out historical comparisons of this market to any in recent or distant memory. This isn't 1929. This isn't 1987. This isn't 1998 or 2000. The only thing those periods have in common with 2020 is the market went down significantly, within a context of a historically relevant market panic.
The impetus to make historical comparisons in the financial markets is driven by the desire to gain insight into what future events may hold for investors. It's only natural then that investors will turn to past to determine the future without thinking how the financial world has been turned on its ear, making all previous periods a moot point.
A number of developments have taken place leading up to this point that make 2020 a completely different creature altogether. Everything from the pace of technology innovation to the nature of the dissemination of information to investors make this environment unique. However, all of it pales in comparison to what the global central banks have done to price discovery in the financial markets.
This has created two sets of investors:
- Economic/financial market moralists who are confident that all of this has to be rectified through a complete financial meltdown that breaks the back of the global central bank cabal, ushering in a new financial system that is yet to be determined.
- Economic/financial market opportunists who are confident that global central banks will succeed for a time in accomplishing asset inflation simply because there is no other choice.
While being an economic moralist creates a sense of intellectual superiority as it allows for the discussion of highly cerebral topics of a rarefied caliber, the economic results in terms of creating alpha for investors simply don't add up to the wasted time and effort.
We are, after all, not involved in the financial markets to act as university professors who dwell quite comfortably in the realm of theory but are unable to gain any practicality from our intellectual endeavors.
To be an opportunist in the market currently is to recognize one simple fact: the Fed is stuck. As a result, they will do everything in their power to become unstuck, although you have to assume that they realize the ultimate futility of their endeavor.
In the end, the hope of the Fed is that they are able to inflate asset prices to such an extent that it will create a demand led recovery in the economy that will remove the threat of deflation.
We have been witnessing for years now a Fed that has explicitly said that they are pursuing inflation. This massive new round of QE is not only a “save the economy from the virus” move. It is also the most significant attempt yet to stoke inflation, as an inflationary surge becomes the only way the Fed can normalize monetary policy in the years ahead.
This leaves investors with one of the more favorable investment environments of the past several decades. You have an investment public and a lot of institutional guys, as well, who are either completely out of this market, short the market or so lightly allocated that they are greeting each tick up with a tightening of their sphincter in agony of further opportunity cost. This is paired with a Fed that is literally fighting for their life within a QE regimen that they have had a decade to think about and perfect exactly for a moment like this one.
Two completely opposing forces with investors looking at the data and saying to the markets “no way does this last” and the Fed looking at the data and saying to the markets “this has to last.”
The market has already spoken as to the winner in this battle of wills. The Fed will win. Investors will be forced back into the markets not just because stocks will keep rising, but also because the economy will be much better than expected during the latter half of the year. The forthcoming data will nullify a great degree of their outstanding concerns, resulting in an uneasy allocation back into the market as the data becomes more accommodating towards investors.
The bearish mantra is so deeply ingrained that it will take a lot more market upside to cause enough opportunity cost that it convinces investors to jump back in with both feet. All the meanwhile, the Fed isn't going to slowdown the monetary stimulus machine. The White House and Congress aren't going to slowdown the fiscal stimulus machine. The economy will react in the same manner as all the underlying catalysts for its eventual reaction......via an overreaction.
Essentially, what you have here are layers of overreaction from every single front. Much like a torrent of water from a tsunami, the overreaction is reaching different parts of the economic and financial market ecosystem at different times and with different levels of intensity. However, what is important to understand is that the entire market ecosystem will be touched by an overreaction.
The Fed is overreacting with monetary stimulus.
The government is overreacting with fiscal stimulus.
The markets will overreact on the upside as a result of stimulus.
Investors will overreact to the market by allocating vast swaths of capital in an incremental fashion.
The economy will overreact to all of the above via what can only be accurately described as a drug induced frenzy as multiple waves of stimulus in various forms create a Q3 and Q4 surge in economic activity.
Layers upon layers of overreaction, all ending in a crescendo the likes of which we have never seen, as there has never been this confluence of factors all working in the same direction at once.
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