Our ability to achieve calmness is rooted in perspective. The current environment poses difficult challenges in finding the right perspective to look at the situations we face. As investors this is particularly true.
There is much to be concerned about. We know the list—lockdowns, unemployment, pandemic, social unrest, political polarization. It is hard to reconcile stock market action with our personal perspectives on the state of the world and our personal place in it. But as I have mentioned before the stock market is about the future not the past. It is not about our personal fears and concerns but about the economy and corporate fortunes.
Even so you might ask if the stock market is completely ignoring economic activity. For example, the job losses in April were a staggering 20.8 million. The seasonally adjusted unemployment rate went up to 14.7%. We were stunned by the numbers but the job gains in May were another surprise at 2.7 million. The unemployment rate ticked down to 11.1%. The number of unemployed is still staggering but the trend is in the right direction. But progress is uneven geographically and by industry. Manufacturing plants and offices are reopening but other businesses such as hospitality and personal services are much slower to come back. If you are looking at the damage done through the eyes of your local restauranteur, the situation is still quite bleak. We may equate the return of restaurants with normalcy, but we shouldn’t extrapolate their difficulties to the whole economy.
One factor that is easily ignored but is contributing to the stock market’s strong rebound is the fiscal policy stimulus and the monetary supports engineered by the Federal Reserve. The Fed has said they will do what it takes even to the extent of buying distressed companies’ debt. The Fed is committed to keeping interest rates at or near zero. This is good for borrowers whether they are individual companies that need funds to maintain or grow their businesses or individuals getting a new or refinancing old mortgages. The impact of low interest rates also impacts stock valuations. If you are not earning anything on your fixed income investments, stocks look more attractive. Relative to US Treasury yields, stocks are actually cheap.
As I have just done, we often talk about the stock market as a single thing. That viewpoint may lead to some wrong impressions particularly in this time period. Is it the stock market or a market of stocks? The strong rebound from the lows of earlier this year in the market averages belies the diversity of results for individual stocks. This is always true, but it is particularly true now. For our example we’ll use the S&P 500 Index. For the year, the S&P 500 is down 2.3% after rebounding 20% in the second quarter. Year-to date the average stock in the S&P 500 is down 12.7%. The largest five stocks are up by 34.2%. Those five largest stocks—Apple, Microsoft, Amazon, Google, and Facebook—represent 27% of the market value of the index and so have had an outsize impact on the total index returns. What they have in common that they are all beneficiaries of the current environment. That those stocks would be strong in the Covid19 era makes sense. They are current beneficiaries of the trends of digitization, e-commerce and work from home that will persist. Most companies will be fine eventually. For some companies, like those five, eventually may just be sooner. We think of the S&P 500 as reflecting the whole stock market but in this case, it is being strongly influenced by a relatively small set of companies.
Perspective is important in many aspects of our daily lives. For investors it can be hard to stay focused on their long-term goals when the short term demands so much of our attention. The key to success is to separate short-term vicissitudes from long term trends. Stocks may look “cheap” relative to bonds, but bonds still have a function in portfolios. Some stocks will benefit from changes in consumer behavior, but many more others will adapt to the new environment and prosper.
So perspective matters. During times of turmoil it is important to stay focused on the long term and not overreact. People are remarkably resilient and adaptable. The economy is just the sum of all that. We will change our work and spending habits and even eat meals away from home and travel abroad again.
“What you see depends not only on what you look at, it depends on where you look at it from.