what is driving the stock market?
covid-19, presidential elections, stimulus and zero interest rates. what the hell is going on with the markets? Join me along with bud kasper, president of the lee summit office, as we discuss what’s driving the stock market.
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what’s driving the stock market’s rapid recovery?
Dean: Alright buddy, here we are, we’re having this conversation on July 29, 2020.
bud: yes, actually.
Dean: We are about to end the hot month of summer and it has been a hot month in the stock market. we saw some good things happen and some good recoveries. I think the biggest thing on people’s minds is, “what’s driving the stock market rally to be so fast? what is driving the stock market?”
The confusing part for a lot of people, and honestly, it can be confusing for professionals like us with 70 years of combined experience. companies are having a hard time even providing guidance on what their earnings will be because the economy is still in disarray due to covid-19.
outbreak: no doubt. I mean, let’s face it, some companies are absolutely devastated. now, you ask, “what is driving the stock market and this economy at this particular time?” the market is reacting to the stimulus program coming from the government and the federal reserve, keeping rates low. but what is more important, the entry of the fed and the control of the bond market, which was a critical situation. I’ll make an even bolder statement than when the Fed finally came in and said, “we would be the buyer of last resort for all the bonds.” that was perhaps the most terrifying information I have come across in 38 years. if the bond market crashed while the stock market also crashed, the insecurity associated with this could have been catastrophic.
many unanswered questions
Dean: If we look at the great recession of 2008, and when we went into 2009, things still looked bad. there was still a lot of uncertainty. And yet, the market rallied aggressively in 2009 after its lows on March 9, 2009. The reason it rallied aggressively was because the Federal Reserve enacted a zero interest rate policy. in that commitment to keep that low interest rate and quantitative easing, which was also a stimulus, the term “don’t fight the feds!” was coined and became very accurate.
Even though there is so much uncertainty around corporate profits and people don’t know what’s coming next, they are asking questions like “when are we going to get back to full employment? when will the consumer be able to go out and spend and do what he normally does? will there be a vaccine this fall? what about in the spring will there ever be a vaccine?”
We don’t know the answers to those questions. but what we do know is that we have the support of the federal reserve, and we have the support of the congress and the president of the united states. I think the market believes that the government will do whatever it takes to keep the economy going and support the markets, whether it’s the stock market or the bond market.
It was evident when we started seeing these multi-billion dollar stimulus packages, the stock market just took off. let’s take a look at what’s going on.
bud: Let me add one thing to your comment. March 9, 2009, as you noted, was the low point. we did not see a surge in the stock market. it took all summer to regain competition from the federal reserve program.
index performance to date
Figure 1 | Source: Chaikin Analytics
What we are seeing in figure 1 are the different rates from one year to the date. and so we have so much disparity in where there are returns and where there are no returns. looking at this chart, the red line near the bottom is the s&p 600 small cap. we can see that small caps are still 16% down on the year. that’s huge. there is no reward.
let’s move on to the s&p 500, which is essentially a flat line. it is down 0.21% at this time. okay, what’s on top? I don’t think it’s a surprise that it’s the nasdaq composite. the nasdaq composite is 20% higher. what does that tell us? we see a 37% spread between small caps and technology companies, or the nasdaq, this year in seven months. what does that tell us?
bud: well i think we have a situation where the big five tech companies are driving returns, both for the s&p 500 and for the tech sector. explains what we are experiencing right now. if you look at it now, the s&p 500, 25-26% of the s&p 500’s performance comes from technology, and specifically, from those five companies, facebook, amazon, microsoft, alphabet, and apple.
what about bonuses?
Dean: Now, that’s happened before, right? It happened in 1999, just before the dot-com bubble.
so what are people saying today? “Well, if I’m going to make money, I need to have great technology.” And right now, it’s true. go back to 1998, 1999, man. what people said back then was, “you know what? the old style of brick and mortar value companies forget about them. now everything is going to be technology”. And when the tech disaster happened, we saw the technology drop by 70% in two years.
outbreak: vs 47% for the s&p 500 index over the same period.
Dean: But what worked well in 2000 and 2001?
dean: correct, bonds, financial stocks, and stocks that pay high dividends. such good value for money it did very well. what I mean is don’t get into a position where you’re always chasing performance. Don’t forget asset allocation. do not forget about diversification. Sometimes you may feel like you’re missing out on something, but if you want to make sure you’re smoothing your ride as much as possible in the stock market. you still have to have diversification.
what’s going on in the s&p 500?
bud: yeah, from a historical perspective, if you think back to the ’20s, ’30s and ’40s, dean, how do we judge performance in the stock market? the dow jones industrial average. why? because we were a manufacturing economy at the time. In 1957, Standard and Poor’s came in and said, “That’s not a fair way to look at today’s market.” So, they divided the market into 11 different sectors, and filled each of those sectors with the stocks that best represented this sector. and that was a good way to really gauge what the broad-based market was doing.
but if i told you that technology today accounts for 26% of the s&p 500 index’s return, what does that tell you? the s&p has been biasing the portfolio toward technology. why would they go about doing that? you’re seeing all this money going into pension plans, ira accounts, and individual accounts that are invested in the s&p 500. and if that were weighted the same, you wouldn’t get the returns that you’re getting from the s&p 500 that you do today. /p>
sector performance to date
Figure 2 | Source: Chaikin Analytics
Dean: Well, here’s why. see figure 2 above. figure 2 shows us the different sectors from one year to date. let’s start at the top with information technology so far this year, plus 15.21%. it can scroll down and we only see four sectors that are in positive territory. when we come to the s&p 500, it is not a sector, but more of a benchmark. is the one that is flat. ok, so what do we see? basic consumption, negative. materials, negative. profits, negative. real estate negative industrial, negative. financial, negative. down at the bottom, which shouldn’t be a surprise, is energy, negative 38%.
sees a 53% variance between the best sector and the worst sector in the s&p 500. the average of those sectors, weighted within the s&p 500, gives us the flat return this year. but you may have a tendency to want to be overweight in technology because that’s where the money is made.
Is the stock market overvalued?
I think the question we have to ask ourselves is, and a question we always ask ourselves, Is the stock market overvalued? Is it undervalued? Or is it highly valued? I encourage everyone to check out the blog post that my brother Shane, one of the partners here at Barber Financial Group, wrote about market valuations. It is a very detailed and in-depth article. we’re going to go through just one slide from that particular article. but if you read it, you will come to the conclusion that today’s markets are really overvalued.
bud: from a profit perspective and all that, and shane did a great job on that article. I encourage everyone to go and read it. however, when we look at this trailer, what concerns do we have? well, coronavirus is number one, but number two is elections. What possible consequences could it bring to the stock market once the elections are over?
Dean: This whole concept goes back to when we do financial planning using our Guided Withdrawal System™. we do our best not to take unnecessary risks; in other words, don’t get greedy. do not assume more risk than your portfolio needs so that you can meet your financial objectives.
valuations, what should we expect?
Figure 3 | Source: Advisor Perspectives
Let’s see this valuation chart in figure 3. this particular chart compares four different measures of valuation. there is the crestmont pe of its geometric mean, the cyclical shiller pe, and then the relation q. Also included is the S&P 500 from your regression.
The best valuation you can see in Exhibit 3 is the capitalization ratio, the cyclical pe 10. The capitalization ratio shows that the market is now 88% overvalued. below, at the bottom, you can see the years. So in 2000, you can see the dotcom bubble, right? if you take a look at where we are today with different valuations-
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bud: looks pretty similar, doesn’t it?
dean: That’s right, that’s what we’re talking about, it’s the similarity with today. Just because valuations are where they are today doesn’t necessarily mean they’re going to crash, right? there are two different ways those valuations can go down. we need to see better earnings, and that will drive those valuations down.
bud: For that to happen, the economy has to recharge.
dean: We have to recharge that economy. And I think we’ve seen this rise in valuations because corporate profits have plummeted. Right?
what to expect from the economic recovery
Dean: As the economy recovers, and you can see what’s happening in the market today, the bet is, “the federal reserve is coming in, congress is coming in, we have stimulus and they have zero interest rates. they’re not going to let this economy fail. they’re going to keep it going for the good of the American public and for the good of the normal taxpayer trying to make a living.” right?
Dean: When this picks up, I think this price-earnings ratio will start to decline naturally. however, we need to be aware that we may not get a vaccine in the fall or spring, and this covid situation could continue for another 18-24 months. if it continues, I don’t think there’s any way these valuations can be sustained over that period.
bud: I totally agree with that. in the intervening period, the stimulus is so great that it should probably continue to drive the stock market, i guess. I think we are going to have flat returns as we get closer to the election. after that point, katy locks the door; I don’t know what’s going to happen
two factors in economic recovery
Dean: What happens next, friend, depends on two things:
- who wins the election
- how soon will we have a vaccine
dean: so, until then, you and I and all of our advisors here at barber financial group are looking at this every day. We’re watching your wallets. I want to encourage you to share this information with your friends, share the video, subscribe to us on youtube and follow us on facebook. stay connected with the different content we write every week and the videos we post.
thank you for being part of barber financial group. If you are not a client and would like the opportunity to visit with one of our advisors, please give us a call or schedule a free consultation below. let us know you would like to have a conversation. we will schedule a no obligation visit, which can be done by phone, zoom meeting, or you can come in person as bud, and today i’m sitting here next to each other. I hope everyone stays healthy and safe. thank you for taking the time to join us today.
dean barber founder & CEO
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Opinions expressed represent the opinion of Barber Financial Group and a Sec. The information provided is for illustrative purposes only and does not constitute legal, tax or investment advice. barber financial group accepts no responsibility for the use of the information discussed. consult with a qualified financial, legal, or tax professional before taking any action.