The market is up- way up – and the economy is “not so much.” Temporary furloughs are becoming permanent and the resiliency of the consumer, and by extension an economic recovery, is possibly waning. What might explain this disconnect?
First – we need to accept that in the short term the market is not the economy. Longer term, the health of the economy will bend, one way or the other, the trend line of both the equity and the bond markets. For now, however, let’s look at a focused time frame of this quarter and the next.
The Federal Reserve watches the real economy and its mission is to keep that economy infrastructure steady. And right now the Federal Reserve is “all in.” We are told by all Fed speakers that they are looking at very low yields for a very long time – several years. This low interest rate environment not only gives companies some incentive to continue with growth projects, keep or restore employees on payroll, and repair their balance sheets, it also supports higher stock prices relative to their earnings. And then there is “TINA” – there is no alternative. When we see stock dividend yields higher than most fixed income and certainly Money Market funds, money easily flows to those Large Cap companies which are more resilient, are perhaps seen as safe havens, and pay attractive dividends. When we look at the inverse of the p/e ratio, the E/P ratio (earnings over price), most analysts believe they see the earnings yield at a comfortable level. So, while the stock market valuations might be stretched to “priced for near perfection,” a market disconnect from the economy at ground level may be okay.
What could go wrong? For starters, this positive picture is dependent on a 0% or extremely low interest rate environment. If the Federal Reserve moves off or substantially reduces its support of the economy, we might experience some bad news for stock market. Consider the “good news” of a viable and accepted use of a COVID vaccine turning into “bad news” for the stock market as the Federal Reserve removes some support and allows inflation to run a little hot, as they suggested at the recent Jackson Hole meeting. Rising inflation usually pushes interest rates up, and that would have a negative impact on several areas of the economy, not the least of which are autos and housing which is red hot today.
I believe we are witnessing an acceleration of a digital revolution, a change we might have seen playing out over the next several years, now compressing into a period of months. The rapid move into highly networked, not at the office workspaces, the “rightsizing” of many industries causing permanent layoffs but adding to profitability, the profound alteration of retail moving to e-commerce – these changes should accelerate volatility in the next several months as the equity market adjusts to a new economic structure both here and globally. The bond market will adjust on a daily basis, and we prefer to remain invested in shorter duration fixed income which may be less effected by spikes in ten year to thirty year interest rates.
Navigating this investment environment is more challenging than ever primarily due to the fact that the global pandemic is not over. The long term health of the economy depends on the health and resilience of us all.
While we know that every environment brings some opportunity as well as challenge, a few maxims remain the same:
- Practice dynamic diversification – keep bonds in the portfolio when only stocks are growing and keep stocks in the portfolio when the only safety seems to be in government bonds.
- Continue to invest through good times and bad because the good times always last much longer than the bad.
- Keep some cash on the sidelines for your emergencies and for opportunistic buying when most others are selling.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
All investing involves risk, including the possible loss of principle. There is no assurance that any investment strategy will be successful.