Don’t Panic: This Time Won’t Be Different

Last week, the S&P 500 (SPY) moved upwards, reaching new highs. And then it fell – over 4% in two days. This has led to a rather large number of articles popping up all over the web, concerned that the market crash is coming.

The S&P 500 is up 9% in the past 3 months and up 15% in the past year.

Many have pointed to the fact that the Fed’s endless printing of money has created a massive divide between the real economy and the stock market. After all, they argue, the stock market is up so much while we’re living in the worst economy since World War 2.

And it is true, monetary policy, especially in the form of quantitative easing, whereby the Fed prints money to buy bonds, doesn’t exactly get the money into the right hands, if reinvigorating the economy is the goal.

Yet, the Fed has increased its balance sheet by $3 trillion this year, from $4 trillion to $7 trillion. That increase is the equivalent of 3% of all US household wealth, or 15% of annual US GDP.

Now, one must ask, wouldn’t creating so much extra currency make the dollar worth less? It is simple economics – if there is more of something, all else held equal, it should be worth less.

(Source: MarketWatch)

Looking at the above chart of the Dollar Index this year, this would seem like a fairly simple observation.

And so, if the dollar is worth less, all else held equal, shouldn’t other assets be worth more dollars?

Take a hard asset like gold, for instance. Its supply is well-known, so pricing it in dollars means it is a mostly effective (although volatile) measure of the perceived value of a dollar.

Relative to gold, relative to currencies, the dollar is worth less. So shouldn’t it follow that if the dollar is truly worth less, other assets, such as stocks, should be worth more?

The below chart of the S&P 500 could suggest this.

Is the market really up or is the dollar just down?

Whether you agree with my somewhat simplistic way of viewing it, we can surely agree that the Fed’s money printing does prop up markets. But it does very little to prop up the economy. To prop up the economy, the ball is in the government’s court. And while fiscal policy has been largely ignored in favor of monetary policy in the past decades, we’ve seen somewhat of a resurgence this year.

This is probably best seen with the US distributing “helicopter money”, through the form of stimulus checks. If you want people to consume, give them cash. Data shows that this has led to people spending the money on food, utilities, or rent.

The Coronavirus Aid, Relief and Economic Security (CARES) Act, which was a staggering $2 trillion with maybe a second round of relief coming, was classic fiscal stimulus.

A combination of monetary stimulus and fiscal stimulus has occurred. Yet, most feel as if recent highs in the stock market have created a disconnect with the economy. But is that really the case?

Not all the market is up . . . it’s not even close

The S&P 500 has reached new highs. So have many tech darlings. But using this market-weighted index as a proxy might not be the best way to view

During the past 3 months, the S&P 500 has gone up by 9%. This isn’t the case of most stocks by a long shot.

It turns out 68% of stocks have gone up less than the S&P 500 index. In fact, half of all stocks in the US are either flat or down in the past 3 months. Extend that to the past 12 months, and you once again have the S&P 500 beat 70% of all stocks, except this time, 58% of all stocks are either flat or down.

One might ask, what is driving the indices large gains? And, of course, one would already know the answer. The 5 largest stocks, which account for 20% of the index, have been firing on all cylinders these past 3 months.

Let’s look at another metric, P/E ratios.

The table above puts into perspective the large 29x P/E of the S&P 500.

(Source: Multpl.com)

Once again, the S&P 500 isn’t quite representative of most stocks. Its P/E is higher than that of 66% of individual stocks.

It is interesting to note that 40% of profit-making stocks are trading at P/Es less than 16x.

What’s the point here? Not all stocks have been going up like crazy, and not all stocks are trading at insane valuations. Of course, this is something that index investors can’t do much about. But for active investors, it means that worrying about the demise of the market might not be warranted.

Volatility has been high and that will continue

This year has been more volatile than the past few years. You don’t need any data to know this.

(Source: Google Finance)

The above chart of the VIX (VXX) shows that it is undisputable. Volatility has been sky-high since March.

You should expect this to continue. The influx of individual investors into the market this year might have something to do with it.

In a recent WSJ piece, it was highlighted that individual investors had gone from trading 15% of all shares traded last year to 19.5% of all trading this year. The case made is that as individual investors make up more of the market, volatility goes up. The WSJ journalist mentions places like Shanghai and Korea, where individuals account for more than 80% of the shares traded, and where “individuals can create a casino-like feel, with exuberant bull runs followed by spectacular crashes”.

So, while pockets of the market still remain undervalued, you should brace yourself for more turbulence and volatility. 

Calm down: This time won’t be different

Ask yourself this question: Why are you investing?

If you’re anything like I am, it is because you want to live off of your investments in retirement. Planning on capital gains to get you there can be extremely stressful, especially this year.

Here’s the thing:

You can make economic data support any story you want to tell. It is important to not get sucked in and caught in the noise. Focus on your goals, on finding good value investments (even when they become scarce), pruning your overvalued ones (even if you like them a lot), and if you want peace of mind, consider an all-weather approach of gold, equities, crypto, indices, and emerging tech.

We’ll get through this together.