People are funny
There was an unmistakable tone of anger in some of my calls this week. After an innocent (my word) discussion of the economy and the markets, a man during Q&A tried to pick an argument with me surrounding the political aspects of the recent protests. (This girl’s skin is decades too tough to get nonplussed.) So it goes in the times in which we live. J.P. Morgan sees populism’s appeal as a casualty. Whether on the left or right of the political spectrum, six presidents/prime ministers whose policy platforms have melded some combination of nationalism, self-sufficiency and mistrust of public and international institutions have experienced significant drops in their approval ratings—Gallup puts President Trump’s rating at 39%, below that of any president who went on to win re-election, and betting markets keep raising the odds of a Democratic sweep. By contrast, world leaders associated with liberal democracy and internationalism have seen significant increases in favorability. Pandemics should be good for populists, exacerbating economic, social and geopolitical stress and validating their critiques of other countries (“the virus came from there”), institutions (“the World Health Organization failed”), specialists (“what do doctors know”) and elites (“only they have access to health care”). And this has been the case—for populism. J.P. Morgan’s populism sentiment gauge, which tracks news flow around themes such as income inequality, immigration, protectionism, nationalism, corruption and elites, has surged to 12-year highs. In my new Behavioral Finance presentation, I discuss cognitive dissonance bias—people see what they want to see. And right now what many see has them blaming their leaders, even if their political views arguably align. If we are witnessing a paradigm shift away from populists, J.P. Morgan suggests markets could be in for a renewed period of fewer and smaller bouts of extreme volatility. A silver lining, no?
In another part of my Behavioral Finance presentation, I define anchoring bias: investors have a hard time handling abstract figures, so they anchor onto the initial value. Fundstrat believes this bias explains why so much cash remained on the sidelines during the 47%, 2.5-month ricochet off the March 23 bear-market low. While there have been some flows into the market, it believes much of this has come from millennial investors using the popular and commission-free trading site Robinhood. At nearly $5 trillion, there’s still about $1 trillion more of investable cash than at the start of the year, a pile baby boomers let sit after a crash that was so fast and a bounce that was so fierce that they found it all to be crazy. Fast-paced algorithmic-driven trading is largely foreign to this group, which controls 76% of the nation’s wealth. Moves like yesterday’s huge sell-off only reinforce this anchoring bias. They also reflect yet another Behavioral Finance tenet, the Gamblers’ Fallacy/Monte Carlo Fallacy bias. This is a belief that if an event happens more often than normal, it is less likely to happen in the future. So it was that the fear of missing out (FOMO) ensnared so many on the wrong end of the trade Thursday.
Near-term messiness after the swiftest rally off the swiftest bear-market downdraft had been expected. Over the last two weeks, the percentage of advancing stocks and advancing volume on the NYSE fell in the 99.9th percentile of every historical observation—Strategas Research says such a remarkably rare “breadth thrust” is almost exclusively found in the initial weeks and months off a major market low. The S&P 500 also had been trading about 13% above its own 50-day moving average, another 99.9th percentile event. Until this week, Yardeni considered the stock market equation since March 23 to be: TINA (There Is No Alternative) + MMT (Modern Monetary Theory) = MAMU (the Mother of All Melt-ups). Still, the magnitude of yesterday’s 1-day down move was a shock. Seasonality, a gloomy Fed and jump in Covid cases in Sunbelt states were blamed. I call hogwash. How about blaming 99.9th percentile events? Something had to give, and yesterday, it did. Massive stimulus around the world continues to show up in data, making another retest of March’s lows most unlikely. Support in the 2,900-3,000 zone is an important line of defense. People are funny, or if you like, our humanness can affect our investment returns. We are long-term investors, aren’t we?
- Don’t fight the Feds Money growth around the world is accelerating as global central banks continue to ease. In the U.S., M2 (cash, checking and savings accounts, money markets) is expanding at its fastest pace since World War II, Japanese M2 is growing at its quickest rate since January 1991 and in the euro area, broad money accelerated to its strongest level since the global financial crisis. It’s not just central banks. Private sector deposits are also growing very quickly, aided by government injections.
- The Fed won’t go negative In this week’s FOMC meeting, none of the policymakers preferred policy path “dots” fell into negative territory over the next two years, but all but two did show the target funds rate holding near zero-bound through 2022. When asked if he was worried that the markets may be in bubble, Fed Chair Powell said he wasn’t and that the Fed isn’t going to change policy based on a potential or actual bubble.
- Can the recession be nearly over already? The OECD U.S. Composite Leading Indicator spiked a record 0.9% in May, its first increase in four months, signaling an impending recovery from the steep recession in the past several months. Historically, the indicator has troughed a median of three months before the end of recession, which suggests that the next expansion may begin as early as July.
- Deflation is the bigger worry Many grocery items have been rising—May producer prices unexpectedly rose on higher meat prices, although core PPI slipped. But core consumer prices declined a third straight month, though by significantly less than in April when it hit an index low going back to January 1957. The Fed’s forecast sees core CPI slowly rising to 1.7% by the end of 2022, and only to 1% this year.
- Bubbles can last a long time Wolfe Research believes all the additional money printing is fueling another asset bubble, with the wealth-to-income ratio significantly higher than it was ahead of the tech bubble implosion and the housing crisis. It specifically cites signs of speculative activity in cloud computing stocks, companies close to bankruptcy, cryptocurrencies, marginally profitable “unicorns” that went public last year and several highly-valued companies with unproven business models.
- Zombie companies, a worry for another day? One consequence of aggressive Fed support to credit markets and long periods of low interest rates is that it interferes with the process of creative destruction and, Deutsche Bank says, keeps alive companies that otherwise would have gone out of business. Since the 2008 financial crisis, leverage in the corporate sector has increased significantly, with the share of U.S. companies’ debt servicing costs higher than profits continuing to increase.
The markets are starting to focus on the election again Since 1990, declining effective tax rates have accounted for half of the increase in corporate net profit margins and nearly a quarter of total S&P earnings growth. The presumptive Democratic nominee is calling for a $2 trillion tax increase on corporations, raising the headline rate from 21% to 28%.
Rare times June 9 saw each of the top 5 stocks in the S&P rise even as the index declined. This has only happened 15 other times in the joint history of the top 5 stocks (since Facebook’s debut as a public stock on May 17, 2012). Cornerstone Macro did the math and said that’s a probability of 0.76% (16 out of 2,104 trading sessions). Many market participants continue to favor these tech giants (and others like them), while many other investors eagerly are embracing “value” stocks.
Contrary positive Bloomberg’s Consumer Comfort Index—often wrong at extremes—is exhibiting extreme pessimism, a signal that historically has been favorable for stocks.