At the end of March, if I told you that stocks would move to record levels in mid-2020 despite the pandemic, the biggest recession quarter in a century, and a global economy shutdown: you probably would have taken me for a fool.
Yet, that is what is happening now in the United States. As Jesse Livermore wrote: “Financial markets are never “obvious.” They are designed to deceive the majority of people most of the time.”
In 2020, the stock exchanges continue to obey this rule with both the correction AND the fastest recovery in 1 century. What exactly happened? Let’s try to clarify some clarification.
U.S. stock market: Record levels despite crisis
You may know this, but the United States is far from the country that has best managed the Corona-virus epidemic.
In fact, their situation has not improved much, and where many countries have managed to calm the game in recent months, the number of new daily cases in the U.S. remains comparatively high:
However, this has not prevented the U.S. stock markets from achieving one of the best performances of 2020, and it seems that the current situation does not cause much panic among American investors.
As a result, the march 2020 low has been massively recovered (despite the uncertainties), and the stock index is now trading at new highs. What exactly happened, and how is that possible?
As I mentioned in previous articles, one thing to always keep ahead of the stock market (beyond “gross” ratios and indicators such as GDP figures and unemployment rates): these are the “general conditions” (i.e. the global context in which an event occurs).
I’ve talked about the importance of context at the beginning of the site, in an article entitled “how to always know where to put your money” , here are the main principles summarized:
- Economy is cyclical, and each phase of the cycle favours different types of investments.
- There are only 4 major assets (Cash, Equities, Bonds, Physical Assets).
- Money always has to be placed somewhere, and flows between these 4 assets.
- General economic context dictates where money is most likely to be placed.
- Investors always compare these options to each other.
- Investors are always looking to maximize their risk/return ratio.
By keeping these 6 simple principles in mind, and by having a good understanding of the forces that tend to push an asset class X or Y up, or down: you will be better able to make informed investment decisions (and put the odds on your side).
Today (and I’ve posted it repeatedly on the site since 2016): we are in an environment of low interest rates, and low inflation. This means that cash and bonds don’t pay much (to say the most).
The overall environment is therefore inherently favorable to equities (simply because investors have little choice if they want a little return on their money).
If the context favors equities: money can come out temporarily during periods of panic, but basically cannot stay out very long (because the comparative returns on other investments are too bad, which leads to a significant “opportunity cost”).
The stock market is not the economy
Most people expect the stock markets to go up on good numbers and fall on bad ones, but in fact things are not that simple, and the year 2020 has proved it again.
Markets often anticipate
Some bear markets were very short (1987), others were longer (the 2000-2002 market). All had one thing in common: equities set their lows and began to recover BEFORE the economy showed signs of improvement.
I mentioned in particular the case of the major bear market of the 1990s, during which equities had recorded their lowest nearly 2 years before the U.S. economy showed signs of recovery:
Bear market from June to December 1990: -20.3%
U.S. unemployment and growth figures for 1991:
Unemployment rate on the left, Growth rate (negative in 1991) on the right
As you can see here, the unemployment rate continued to rise until 1992, before falling for the first time in 1993. The economy did not start growing again until 1992.
Here’s what happened on the stock exchanges in parallel:
A major bull market from 1990 to 1993
This time again, if you had gone out in the middle of the panic (and you had waited for “things to calm down to buy”): you would have lost a lot of money.
Economy: where are we today?
As mentioned in the previous point, we are now in the phase where the published economic numbers were disastrous, but it doesn’t matter how bad it is, because everyone expected more or less that they would be:
Biggest fall in U.S. GDP since 1929
It may seem paradoxical what we have in this context, looking like this:
5% for SP500 index in 2020 and new highs in August
However, this simply reflects one thing: stock exchange markets are looking to the future and anticipate that the massive economic air hole we are currently experiencing won’t last for long.
Whether they are right or wrong, one thing is certain: by the time concrete improvements materialize in the economic numbers, the majority of profits will have already evaporated. This has always been the case, and will continue to be the case in the future.
That’s why many famous investors talk about “buying when there’s blood on the streets” (Baron de Rothschild added this quote with “even if it’s yours“). However, as we saw this year: it’s not that simple in real time.
Despite the “unprecedented” side of the Covid crisis, some things have continued to happen exactly as they have always done.
Stock market did exactly the opposite of what the majority expected. Everyone has more or less overreacted to the situation (one way or another). Investors who did not move did better than those who were trying to make a recovery. Strong stocks and defensive strategies held up well. And markets continue to look to the future.