One of the questions we frequently get asked is what we think of the level of the market.
This is especially true at the moment with substantial increases in equity prices the world over since March 23.
The first thing to say is that we pay little attention to such matters.
Predicting the short term movements of any asset governed by human psychology is a fool’s errand.
Markets can remain irrational longer than you can remain solvent, to paraphrase John Maynard Keynes.
If pushed, however, we would offer a number of possible explanations of what is driving market behaviour in the short term.
Central banks
1) “Don’t fight the Fed”. This is one of the oldest market adages.
What it effectively means is that only the foolhardy would take an opposing position to the Fed (or any other central bank of substance for that matter).
Markets can remain irrational longer than you can remain solvent, to paraphrase John Maynard Keynes.Although opinions differ on the effectiveness on the world’s healthcare response, one thing to be lauded is the speed with which governments and bankers have acted to protect individuals and businesses from the harshest immediate impacts of economic sclerosis.
Interest rates have been slashed. Unprecedented job retention schemes have been swiftly implemented.
To use the analogy of a game of poker, the Fed has gone all in. In the UK, chancellor Rishi Sunak said the government will do “whatever it takes” whilst launching a £350bn package of loans and grants to businesses. Fighting talk indeed.
Market moves
2) Stock markets don’t move in sync with economic data. Markets are generally forward looking in nature hence the FTSE reading today is looking at least six to twelve months into the future.
If there is one thing that is certain it’s that there will be some degree of economic recovery following months of draconian lockdown measures.
Whether the snap back is as robust as some are predicting, the so-called V shape recession, remains to be seen. A Nike “swoosh” may be a much more plausible scenario in our view.
Rates
3) Interest rates have been slashed and excess liquidity is looking for a home.
Not that long ago the pathway for future interest rates seemed to be up rather than down.
Stock markets don’t move in sync with economic data.Coupled with central banks pumping liquidity into the system, near-zero rates mean a wall of ultra-cheap money looking for a home.
The argument is that at least part of this excess cash is finding its way into equities.
In the US in particular, the day trader is back with a vengeance and there is undoubtedly an element of speculation going on in certain stocks.
Why else would the stock price of Hertz, a car rental business that declared bankruptcy in the US in May, have risen by over five-fold during the first few days of June?
But the absolute level of the index today doesn’t concern us.
Winners and losers
At the moment we view both the Dow and FTSE readings as little more than numbers on a roulette wheel.
Trying to gauge the correct level of markets in the immediate aftermath of a major shock to the economy and society is clearly an imperfect science.
There will be big winners and big losers. Just as lockdown was the easy part for governments and the reopening of the economy much harder, the knee-jerk reaction of equity markets since February was in many ways the easy bit.
As the fog now clears, we believe we are about to enter a period of truth, one where fundamentals will regain their importance.
At the moment we view both the Dow and FTSE readings as little more than numbers on a roulette wheel.Company announcements since March have focused – quite rightly – on emergency actions of self-preservation.
Furloughing staff, cutting dividends and turning off the capex tap, are all quick ways to conserve cash.
But, going forward, company announcements will be scrutinised less for short-term actions and more for what the new normal looks like. Now that lockdown is being eased, what is the real impact on revenue, profitability and cash generation over the long term?
Does the investment case still hold? Does the company’s raison d’être even still exist? We are about to find out.
The second half of the year, therefore, will be less about the movement in markets as a whole and far more about the performance of individual companies.
In our view, this will be very much a stock picker’s market, giving active managers a golden opportunity to prove their worth over increasingly popular passive investments.
Eric Burns is a chief analyst at Sanford DeLand Asset Management
