The Season of the Witch

I’m really having a hard time letting go of this. I just can’t seem to get my arms around it. I mean our unemployment rate, announced this morning, shows that 14.7% of Americans are now unemployed…and the Nasdaq 100 is up on the year? Even the S&P 500 is now only down 10% on the year. Ten percent? Hell, our unemployment rate just jumped that in one month! What’s ten percent among friends, right? How can we even sit here with a straight face and say that the stock market is a reflection of economic conditions, when there is this obvious disconnect between people’s day to day reality and the daily rally in the stock market telling us “Everything is Awesome.” 

Over the short run we have come to expect and realize that the ebbs and flows of the stock market really have nothing to do with the economy. By its nature, the stock market is just more volatile than the economy, so naturally shorter-term moves don’t accurately reflect longer term consequences for the economy. But what really qualifies as short-term? Is it restricted to day to day, week to week, or do monthly, quarterly or even yearly moves qualify as short-term? John Maynard Keynes famously said, “In the long run we are all dead.” Maybe the short run is somewhere between one day and our eventual death.

Keynes spent a lot of time discussing the stock market in many of his works, and he has a number of very apt, and well-referenced quotes on the matter. He understood that the market is not so much a reflection of current economic conditions, but a projection of what those economic conditions will look like in the near future. On the nature of speculators and speculation as a whole Keynes wrote, “They are concerned, not with what an investment is really worth to a man who buys it ‘for keeps’, but with what the market will value at a year hence.” He goes on to reason, who would pay “25 for and investment (with)…a prospective yield of 30, if you also believe that the market will value it at 20 three months hence.”

Applying this logic, it is easy to see how market momentum operates. After a major readjustment of share prices, like we experienced mid-February through mid-March, an updated market narrative can begin to evolve. This new narrative evolves and then begins to take hold. The narrative is that in a few months the economic picture will begin to look much brighter than it looks today. People begin to buy securities that they imagine they will be able to sell back at a profit in short order. As the narrative and momentum build, stock prices rise higher and higher. Like the pessimism that preceded it, the optimism for “economic revival” begins to take hold and soon it is the well-accepted doctrine that “We will be all back to normal and better than ever in no time at all.” This is the nature of bull markets and bear markets, the spread of a narrative and eventual adoption by the masses.

Currently our question is whether this is a real bull market or just a bear market rally. It’s a difficult question to answer because they both look fairly identical at the beginning and middle stages. In fact, what effectively confirms that this is a true bull market and not a bear market rally is whether the market can reach new higher “high” levels, which in this case is still another 17% above current levels. At this point you may be saying to yourself, “Seventeen percent would be a great year by most stock market measures and you’re telling me I have to wait that long for a confirmation of a bull market?” Sadly, the answer is yes, but at the rate we are going it probably won’t take a year.  

 At this stage, there is as much likelihood that this is a bear market rally as there is that this is a real bull market. If you want an analogy of how bear markets operate think about the horror market genre, think about Jason from Friday the 13^th.  Nearly every horror movie, like nearly every bear market, follows the same script. The villain, or monster, attacks his victim, in what kids now call a “jump scare,” that first startling moment of terror. The victim escapes and runs off. Then at the moment when the victim believes she or he is safe, the victim stops and breathes a sigh of relief. It is at the moment of relief that the villain makes his ultimate attack, and the victim is helpless. Bear markets are like this. Bear markets startle us with the first dramatic “jump scare”. Then the offer us a moment of relief and belief that we are going to be ok. Perhaps we’ve gone back to the “peace and security” of our bedroom, certain that the worst is past us—we become complacent. That is the moment when the bear market shows its true identity. Unfortunately, like the end of all horror movies in which we don’t know until the credits begin rolling if the villain is truly dead or not (spoiler alert he’s not, there’s always a sequel), the bear market’s death needs to wait for the credits as well and that is only confirmed by making new higher levels.  

Why should we expect anything less? In a time when nearly every company on the planet is refusing to offer guidance on future earnings, why should we expect to have much clarity. Most of the problems affecting us today are beyond our control. Wait on a virus to depart or to be solved by the arrival of things we don’t yet possess, that is the essence of uncertainty. For now, we have to be patient.

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