Making Sense of the Recent Record Rally
by: Edward Magi, Analyst - Financials & Real Estate
Over 26 million Americans have filed for unemployment in a matter of weeks. People are staying in lockdown and businesses are closing their doors. Oil prices are at two-decade lows, with future prices going negative this past week. Yet, the Dow Jones Industrial Average (DJIA) is on track for one of its best one month returns since the Great Depression.
People in and outside the investment community are finding this news puzzling, as each day we are bombarded with a myriad of horrible economic data. While we’re seeing big moves to the upside in magnitudes not seen since the Great Depression, we’re also seeing economic indicators cratering to levels not seen since then either. So why is the stock market rebounding the way it is when news just gets worse and worse?
The simple answer is that economic data is backward looking while the stock market is forward looking, as investors price future expectations into stocks. Investors, both retail and institutional, may feel as though they do not want to “miss the boat” and be left behind when the economic outlook strengthens. These upswings are showing that a great deal of people are seeing the light at the end of the tunnel here, as the Government and the Fed are taking unprecedented measures to stimulate the economy and states are looking to open up in the upcoming weeks. Whether we will re-visit the bottom before the previous highs is uncertain, and more transparency into the economic outlook will be required to make this call.
In the past, market participants have done a fairly good job in correctly seeing the other side of economic downturns, as markets have bottomed out an average five months prior to the end of recession. It’s likely this time around that we will see a similar outcome (and maybe it has already started).
Part of what has led this record rally has been major gains on the backs of a few of the biggest names in the US stock market. Currently, the NASDAQ Composite Index is roughly the same size as the MSCI World Index ex-US. Microsoft’s market cap has grown to be nearly the same size as the FTSE 100. Apple, Amazon, Microsoft, and Google are now all over $1 trillion in market cap and the rest of the FAANG stocks are exploding from their recent lows. What this shows is that the rally in the aggregate can be sustained and propped up by a few names that make up the lion’s share of the market. With about a third of the companies in the S&P 500 announcing earnings this week, it will be interesting to see how investors react to presumably horrible numbers across the board.
When the market bottomed out in March, the Skyhawk Investment Group looked to find stocks that we felt would have been beaten down too hard. Specifically, we added two new positions in Amazon.com ($AMZN) and Crown Castle International ($CCI) while adding to our position in MACOM Technology Solutions Holdings, Inc. ($MTSI). We felt as though Amazon would likely benefit from heightened demand in the ecommerce business and we like the exposure to defensive secular trends like 5G expansion in CCI and MTSI. We are still on the lookout for more stocks that are trading at attractive valuations and have defensive secular exposure.
Michael Batnick of Ritholz Wealth Management recently responded to this phenomenon by saying that “market participants are drinking a cocktail of different investor time horizons, risk preferences, fear, greed, and hope” and as this cocktail is shaken up, we are seeing some moves that “defy logic, both up and down”. I feel as though this analogy perfectly captures what’s going on in markets today.
It’s easy to be frustrated when Wall Street diverges from Main Street today, but the most important thing to consider is that stock market participants are forward looking. Looking toward a recovery, the stock market will rally before economic news starts getting better. That said, uncertainty is clouding over financial markets, waiting for news and events to flesh out, withering away conviction for many investments. The most important question left unanswered here is exactly when economic news will start getting better.