- There seems to be a willingness to look past an absence of revenues and earnings, increasing unemployment, an explosion of sovereign and corporate debt, and devolving credit ratings.
- This market optimism is based upon a huge policy response and faith that a meaningful recovery will be somewhere within the next six to 12 months.
- As investors ignore today's horrible data, history shows that disappointment and negative surprises often spark tantrum selling.
The big question: As the U.S. heads further into a very deep economic recession or depression, will the tidal wave of stimulus sufficiently insulate markets and investor sentiment enough to justify the present return to lofty valuations?
Investor sentiment is key. There seems to be a willingness to look past an absence of revenues and earnings, increasing unemployment, an explosion of sovereign and corporate debt, and devolving credit ratings based on two things: huge policy response and faith that a meaningful recovery will be somewhere within the next six to 12 months.
Investors are doing what they often do: They subscribe to an economic and market narrative that has a number of data points interspersed with hopeful projections. Former Richmond Fed President Jeff Lacker refers to this as "motivated reasoning." Sometimes these optimistic forecasts pan-out and sometimes they don't. Yogi Berra said, It's tough to make predictions, especially about the future." It's very dangerous when wish replaces thought.
While investors appear sanguine in ignoring today's horrible data, history shows that disappointment and negative surprises often spark tantrum selling.
Most stunning to me is the resilience of this period of bull market psychology. In bull markets, bad news is dismissed and good news is embraced. Those offering cautious counsel are criticized as out-of-step Eeyores (Warren Buffet). During these periods, none of the bad news matters until suddenly it does. This is a very old pattern. In the late 1990s Buffet was criticized as old, out of step, and not able to understand the value of the new dotcom world. Prices climbed for several years until they crashed. When they crashed, Wall Street became the Wailing Wall Street as dollars disappeared and the bears took over. The chorus shifted from devout belief in the "new paradigm" to a new cohort of "I knew it, and I told you sos."
Again, this virus and induced economic coma leave the general public and the investing public with unanswerable questions. We do not and cannot know how long investors will be patient, how long markets will rise on the policy response, how low the economic numbers will fall and for how long. Will we be met with a swift, determined recovery or a prolonged slog that revisits the depths of the Great Depression?
Our answer is a quality-only portfolio that holds balance sheets sacrosanct but provides diversity among the fortress companies like Microsoft, Pepsi, and Johnson & Johnson, along with companies that have strong balance sheets, strong business models, limited debt and are still trading at significant discounts. This barbelled strategy seems best suited for core protection and upside opportunity when and as things emerge.
A reliance on data is paramount. Though we would all like this health and economic crisis to be a thing of the past, it is not. It isn't likely even half over (the numbers are still increasing.) I'm always bullish on the long term and believe that prices will be significantly higher over the next ten years. My concern is that the next two years are anything but a sure bet.
Michael Farr is the founder, president, and CEO of Farr, Miller & Washington Investment Counsel.