Thinking about this post, the Stealers Wheel classic kept coming to mind. We seem to be at the natural half time of the COVID pandemic, medical experts have been consistent in that we’ll probably see a vaccine during the first several months of 2021, which means we’re currently stuck in the middle. Stuck in the middle is also the story of US markets. The bond market and Federal Reserve are priced for the absolute worst-case scenario, and the stock market is priced as if things couldn’t get any better. Clowns to the left, jokers to the right, but none of this feels very funny.
I often mention to clients that the bond market tends to reflect a smarter, longer term view, and the stock market is naturally more speculative and prone to craziness. On September 16th, Fed chair Jerome Powell made it clear that rates would remain at zero until at least 2023, and the Fed was willing to watch inflation exceed it’s target. They’re essentially saying things are so bad, we’re going to do everything we can to stimulate the economy until it overheats.
This isn’t ambiguous, in the past they might have said something vague like: “until conditions change.” The new language is very clear, and while open to criticism, nobody trades against the Fed because the Fed always wins. They wield enough power to put the bond market where they want it, and keep it there for better or worse. So, the bond market is in line, and has been in line. To put this into perspective the 10-year US T-Bond is currently yielding around 0.63%, over the last 20 years the average has been closer to 3%. People buy bonds to protect money, and that buying pushes yields downward. After nearly 7 months in COVID world, the bond market remains priced for the end of the world. These clowns are sad, but tend to be smart too.
The stock market on the other hand is priced as if it were in some other magical world. It seems to ignore that unemployment has only come down to where it was during the great recession of 2008. It seems to ignore that overall economic output has been knocked back to 2018. It seems to ignore that corporate earnings, while recovering, are nowhere near where they were in February, and are much harder to forecast given all the uncertainty we face.
The value of stocks can be measured by the price to earnings ratio. This simply looks at how much you’re paying for $1 of earnings. Looking at the largest US corporations (S&P 500), investors are currently paying around $26 for $1 of earnings. Last year, when the economy was solid, this number was around $23, and historically back to 1970 this number averages closer to $19. What do these jokers know that the clowns don’t? Nothing.
There are many explanations as to why stocks prices have been driven up. Some of this is Fed driven, when rates are at zero stocks are naturally worth more for reasons I won’t bore you with here. Some of this is driven by mom and pop investors with too much free time on their hands, trying to get in on the action. Some of this is driven by gamblers with a habit to feed, and a lack of sporting events (the sports betting market is measured in the hundreds of billions). The jokers seem to be running wild.
I’m stuck in the middle with you. Historically, we know pandemics fade into history, and that the world is indeed not coming to an end, but the clowns are very depressed and scared. Historically, we know stocks aren’t usually worth $26 for $1 of earnings even during the best of times, the jokers have lost their mind running with lady luck.
The real answer will be somewhere in the middle. Long before 2023, as inflation rises, the Fed will allow longer term rates to rise while keeping their promise of a zero overnight rate. Stocks will find fair prices as earnings stabilize, and the realities of a long recession take a toll on corporate earnings.
With clowns to the left of us, and jokers to the right, the only place to be is in a diversified portfolio of stocks and bonds reflecting your risk tolerance, and retirement goals.
We’re happy to be stuck in the middle with you, please reach out if you have questions, or would like to talk about your financial plan and portfolios.
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