Scary times often bring out purveyors who, for whatever reason, feel the need to prey on people’s fears. This has been especially true during current COVID-19 conditions. Rather than delve into why I think that is, I’ve instead tried to concentrate on what I think are a few pertinent economic and financial facts that are worth keeping an eye on. Here they are, in no particular order:
1. Contrary to what many may think, bear market draw-downs are actually part of a healthy market. The S&P 500 has experienced 26 “Bear Market” corrections of greater than -20% since 1928. That means on average, they have happened every 3.5 years. Will another severe downturn hit the stock market in the future? Based on history, it would seem to be a pretty good (and easy to predict) bet. One of the reasons we prefer to incorporate tactical positioning into investment portfolios is to help contain or limit downside volatility when markets are weakening, while attempting to reposition into markets that are strengthening or holding their own (in the interest of brevity we’ll save the specifics for future discussion). As to the issue of current market valuation, our indicators are currently, for the most part, neutral. Valuation numbers were actually much higher in 1929, the 1930’s, 2000, and 2008. It is also helpful to keep in mind that conditions of over, or under valuation, can remain in place for long periods of time (even multiple years).
2. Some are calling for another housing crisis, akin to the aftermath of 2008. But, what really led to that event? There were actually a few things, beginning with the fact that people took on way too much debt relative to their ability to pay. Banks also loaned money to people that either didn’t have good credit, and or flat out lied about their income (so called liar loans). Also, there was a lot of leverage in the collateralized debt markets (CMO’s). While the recent pandemic has certainly put some stress on the real estate market, there are definitely a few significant offsetting points: First; The ability of people to pay their loans has recently been at its most favorable point in 40 years. The same holds true for U.S. government debt, with debt service being very low compared to the size of the debt, and compared to the size of GDP. Borrowers were in much better shape going into this pandemic than they were going into the 2008 financial crisis. Second; Mortgage standards are much higher than they were a dozen years ago. Third; Banks have better capital ratios (due in part to financial reform).
3. Millennials are on-track to be a larger generation than the Baby-Boomers and they tend to save less and spend more. While this may not be good for their retirement plan balances, it is certainly good in economic terms (especially with all the money they stand to inherit).
4. Some have pointed to Money Velocity heading lower, and this is valid. But, what is driving it? A big factor is that the Fed has pumped so much money into the economy, that spending velocity has not kept up. Also, banks are required to keep more capital on hand, (compared to 2008) and people are investing more of it. So, in reality velocity has been technically driven lower because of Fed programs (like QE) but not due to a stagnant economy.
5. Finally, with record amounts of stimulus being injected into the economy, there is much being made about hyper-inflation rearing its head. I am not advocating additional debt, but it is interesting to note that despite all of the debt burdens being alluded to by many, there has been little inflation, as measured by the Consumer Price Index (CPI) over the years of the great debt build up since the 1980’s.
Greg Stewart | CIO