October 2020
The Circle of Life
How is any of this actionable?
Stock splits, mathematically, are non-events. But…
Persistence
Wall Street vs Main Street
The story that can be summed up as “the stock market is not the economy” garnered widespread attention in August, so I put this story on my watch list. Will Wall Street pull Main Street along the recovery, or will the Wall Street bubble pop and regress to the Main Street reality? Main Street is not Wall Street, everyone *knows* this. But how closely one measures the other - or perceptions of how closely one measures the other - changes particularly with the political winds. President Trump has favored stock market indexes as a measure of the economy, and being an election year he certainly has given legs to this story.
First is the issue of concentration. As the S&P 500 recovered and returned to record highs, many noted that a handful of stocks can explain the surge with the large majority of other S&P 500 companies lagging. Here’s a piece from Forbes, Why It’s So Hard To Beat The Market:
As of August 26, 2020, the S&P 500 is up just over 9% YTD and the FAANGM stocks have contributed a 9.4% of that return, meaning that the other 494 stocks in the S&P 500 are aggregate net losers.
In the 6 months from the previous high on February 19th through the lows and back to new highs on August 18th, fully 62% of S&P 500 stocks remained in the red over that period (The S&P 500’s return to a record doesn’t tell the full story). And further, the 10 largest companies in the S&P 500 index comprised 29% of the entire index as of July 31st, the largest concentration in 40 years (The market's biggest stocks hold the largest share of the S&P 500 in 40 years as mega-cap tech returns swell). This concentration has persisted; as of this writing, the 10 largest companies still comprise just shy of 28% of the index.
Second is the issue of representation. To the extent that investors view the S&P 500 index as a broad cross-section of US-based businesses, there is concern that this cross-section has become skewed and not representative of future expectations for either market returns or for the Main Street economy. An S&P 500 index fund is now a materially different product than it was at the beginning of this year, especially given recent rotations into mega-cap tech stocks. You know these are unusual times when mega-tech stocks are seen as defensive plays.
Paul Krugman notes that “the economy, although off its low point a few months ago, is still more deeply depressed than it was at any point during the recession that followed the 2008 financial crisis” and that stock prices have never actually been closely related to the real economy (Opinion: Stocks are Soaring. So is Misery.). Krugman goes on to note the forward-looking mindset of market participants as another source of detachment from the day-to-day struggles that millions of Americans are living. Investors buy stocks because they believe those companies will do well in the long run, a very different objective than Main Street folks just trying to put food on the table in the short run.
The question remains whether this market’s investors will liquidate their concentrated tech positions into cash, or stay invested but rotate into different sectors. I am more concerned with the former than the latter. Given quantitative easing, unprecedented prior stimulus, prospects for future stimulus, and a relatively short time horizon for an expected vaccine, I expect price action to reflect investors positioning themselves to tolerate short-term volatility while staying invested in fear of missing out on the eventual full recovery.
What Election?
One early perspective was that a Democratic sweep would be bad for stocks (Biden blue wave sends bearish signal to stocks, and Wall Street Democrat hopes Biden wins, but says it would initially hurt stocks), An anticipated increase in the long-term capital gains tax rate would Likely trigger some degree of selling to realize the lower tax rate ahead of said increase. But that selling may largely be negated by subsequent strategic repositioning or straight-up repurchasing. A short period of selling before reestablishing similar long positions would not change investors’ long-term theses and convictions behind those positions, particularly those tied to holding through an eventual COVID-19 vaccine and recovery.
Subsequently, Goldman issued a report that A Democratic sweep would mean faster economic recovery. In The Macroeconomic Consequences: Trump vs. Biden Moody’s Analytics concluded “The economic outlook is strongest under the scenario in which Biden and the Democrats sweep Congress and fully adopt their economic agenda”. Sure, capital gains tax increases and other policy initiatives would pressure stocks, but other policy initiatives like stimulus and perhaps a more effective COVID-19 response would be a boon to equities.
Markets had a stretch where the only story seemed to be fiscal stimulus. With each conversation between House Speaker Pelosi and Treasury Secretary Mnuchin came new speculation on the Likelyhood of stimulus. Art Hogan observed that the Biggest source of market volatility is virus aid stalemate. Of course those negotiations remained at stalemate through Speaker Pelosi’s deadline to reach a deal before the election, as Senate Majority Leader McConnell forecasted back on October 9th: McConnell Says Any Deal on Stimulus Unlikely Before Election. Hindsight is 20/20 of course, but it is not surprising that neither side wanted to give the other a win prior to the election. There seems to be broad consensus that *some* form of stimulus will be passed regardless of who wins the Presidency, however the size and targets of that stimulus will Likely depend on the election outcome.
Or not! Beyond the politics, it is 2020 after all and nothing should surprise us at this point. I maintain my outlook that these market gyrations are not actionable; it remains prudent to stay disciplined in pursuit of one’s long-term objectives.
Political Parlor Games
I do not recommend stock-picking! Those who do, however, have plenty of recommendations based on a Trump win versus a Biden win (How to invest ahead of the 2020 election, according to top advisors). In Trump’s corner there is perhaps a tailwind behind defense, financials, and the “for-profits” (prisons, schools, student loan lenders). In Biden’s corner there is perhaps a tailwind behind infrastructure, renewable energy, and technology, as well as an easing of trade war tensions with China, while tempered by potential increases in corporate taxes and regulations.
One could go down that road by assembling a portfolio of low-cost ETFs for each sector listed in the article, proportioned according to each candidate’s priorities, assign probabilistic weights that fluctuate according to the latest Likelyhoods of each candidate winning, and of course rebalance daily!
Or how about do nothing? Wondering what to do with your investments if Trump or Biden wins? Try nothing, experts say.
Innumeracy
As they say, what the market taketh away, the market giveth (they say that, right?). Following the economic shutdown in the second quarter that brought the US economy to an unprecedented halt, the President proudly boasted of a record-setting 33.1% annualized GDP growth rate in the third quarter, nearly double the previous record set 70 years ago. To be clear, recovering is good, and recovering sooner is better than recovering later. But the mathematician in me hopes that the President and his followers fully appreciate the influence that a much smaller denominator played in that statistic.
John Allen Paulos’s classics Innumeracy: Mathematical Illiteracy and its Consequences and A Mathematician Reads the Newspaper are needed now more than ever.
ONE MORE THING…
The Circle of Life. Older Americans are selling the stock market, slowly but ceaselessly, to junior generations
How is any of this actionable? Makes my case against most technical analysis. Technically Speaking: Why This Is Still A Sellable Rally, For Now
Stock splits, mathematically, are non-events. But… stock splits do matter for shareholder quality. Here’s the real cost of stock splits that Buffett knows and Apple and Tesla ignored
Persistence. Year-to-date list of The best and worst performing hedge funds in 2020. Anyone want to predict how each of these hedge funds will perform NEXT year in 2021? Depends on your views of Persistence, and whether 1 year is “long term”: Performance Persistence Among U.S. Mutual Funds
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