Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA

Newsletter

February 1, 2021 – DJIA = 29,982 – S&P 500 = 3,714– Nasdaq = 13,070

“There’s Battle Lines Being Drawn, And Nobody is Right if Everybody is Wrong”[i]

 

There was a common and popular plea throughout 2020 and it was for the year to end as quickly as possible.  This widespread wish was based on the belief that 2021 could not come close to matching 2020’s troubles and, by default, would have to be better.  Further, there was hope that life would return to normal as defined by pre-pandemic conditions.  While the New Year is only a few weeks old and optimism reins, signals suggest that 2021 could match or exceed last year’s misery.

Last year we suffered through a pandemic, economic shutdowns, stay at home shut-ins, widespread business failures, and historic unemployment.  As a result, we learned about Zoom meetings, masks, hand sanitizer, social distancing, and Netflix binging.  The situation was intended to be temporary until the case numbers decreased or a vaccine was available.

Another notable characteristic of 2020 was cultural differences and division. Unfortunately, no medical solution will heal this, and, despite calls for unity, the situation is worsening.  The opposing sides appear to be moving farther apart as well as expanding the number of issues of disagreement.  Before you know it, we’ll be yearning for the good old days of 2020.

Our cultural split began years ago and was generally defined along political parties.  This has morphed into the current battle map with squiggly lines that have many angles to define allies and the enemies.  The landscape has turned into a “Uni-Party” of the ruling class and their financial supporters against anyone outside the aristocrat category.  This is no better illustrated than by the walls that were put up to ‘protect’ our elected officials and staffs while the wall on our southern border protecting the rest of us is judged unnecessary.

A new front in this war began last week in lower Manhattan.  A large army of individual investors did battle against hedge funds and traditional Wall Street enterprises.  These firms and banks had made massive bets against some struggling companies via short sales.  This is when someone borrows the shares from a brokerage firm with the intent of returning the shares later.

The hedge funds and traders that are borrowing these shares are betting that the price of the security declines.  Once the price of the stock falls, they then buy the shares that they borrowed at the lowered amount and make a profit. The goal is to make money on a falling stock price.

The short seller’s risk is that the stock price increases after they sell the borrowed shares. The borrowing firm must return the shares so any increase in price will result in a losing trade.

The hedge fund and large traders had targeted some businesses with significant challenges.  One of the lead companies in this confrontation is GameStop, the world’s largest video game retailer.  They are facing a network of stores which increases fixed costs, declining sales, shrinking margins and increased competition.  This appeared to be the flawless short sale situation.

Hedge funds and their colleagues took dead aim and sold the stock with both fists.  The strategy got so popular that over 100% of the float (the number of shares outstanding less shares held by insiders and other restricted shares) was shorted.

This extreme positioning got the attention of a group of individual investors who used a Reddit.com chat room to exchange ideas.  They bought GameStop which dramatically drove the price higher.  Then others saw what was going and bought the stock.  The shares jumped from under $20 to almost $480 in two weeks.  Other heavily shorted stocks also were bid up in similar fashion.  AMC Entertainment, Nokia, and Blackberry.  They had one thing in common – they were heavily shorted.

The higher price caused indigestion among the players that were short, and many were forced to cover (buy the shares to repay the shares on loan).  Some hedge funds lost billions of dollars and one of the hedge funds, Melvin Capital, had to get bailed out due to large losses.

This saga is a classic David vs. Goliath.  The Reddit Rebels, a diverse group of individuals, combating the sophisticated and shrewd Wall Street.  This band of individual investors initially got the upper hand as they drove their targeted stocks higher and forcing losses and pain on the hedge funds.

Then the plot took an unexpected twist as Wall Street unilaterally changed the rules.  Without notice Robinhood, a popular trading app, restricted “buy” orders in the names that the hedge funds were short.  Without the Robinhoodies’ buying support, GameStop fell from over $450 to under $200 in one day.

The developments behind the restriction are unclear.  Some claim that Robinhood had too little capital but that doesn’t explain why only a few stocks were banned.  Others claim that large hedge funds pressured Robinhood so that they could recover some of their losses.

The battle eventually turned into a public relations dispute as media outlets and regulators defended the established Wall Street crew.  Some claimed these were necessary measures to maintain Wall Street’s integrity.  Others declared these small traders were an attack on the free market system.  Finally, one compared the Redditors to insurrectionists like those who invaded the Capital offices and labeled them as a national security threat.

These allegations were hyperbolic media manure.  “Free markets” is an anachronistic term.  If global central banks manipulate interest rates and the capital markets (as they do now), we are not in a free markets system.  Further, “integrity” and “Wall Street” is a laughable and blatant oxymoron.

Reddit defenders accused the hedge funds of collusion as they suppressed trading access and manipulated the stock market for their gain.  Besides Robinhood, other brokerages firms like TD Ameritrade and Charles Schwab abruptly restricted trading in GameStop and other popular Reddit stocks.  There was no mention of capital calls for these firms.

As retail investors took on the establishment, they got support from a wide and surprising diverse group.  Donald Trump, Jr. complained, “This is what a rigged system looks like, folks!”[ii].  New York Congresswoman Alexandria Ocasio-Cortez was equally critical of the brokerage industry pointing out that the people who have treating the economy as a casino are angry at a group of individuals doing the same thing.

While the outcome is uncertain, GameStop may be a one hit wonder for the Redditors.  To be sure, there will be other stocks to trade, but one obvious conclusion is that some of the participants need more financial education and trading experience.  Nevertheless, there should not be some nobility restricting their freedom to execute their decisions with their own money in the capital markets.

This conflict has multiple parallels to the censorship and suppression that is spreading across our culture.  Those who question the aristocracy or refuse to mouth the party line are being a targeted as threats and must be punished.  Political leaders, bureaucrats, and big tech have combined to police our society.  Similarly, those who challenge corrupt insiders in the financial industry are being besieged as evil radicals that must be destroyed.  The view from the Wall Street and Washington insiders is that this uprising and challenge to their position must be squashed at all costs.

While this war raged, there was worry that it would become systemic and deeply impair the capital markets.  Hedge funds use massive leverage in their trades.  Also, there is a great amount of duplication within hedge fund positions.  That is one of the reasons behind the astounding amount of shorts on things like GameStop.  As many firms were losing billions due to the Reddit Rebels, there were concerns over critical failures within the hedge fund community that could pull the system down.  It hasn’t happened – so far.

It is encouraging that the capital markets have withstood this dramatic tale.  However, stocks did selloff in the last 4 trading days of January and the Dow Jones Industrial Average and S&P 500 closed lower for the month.  The small cap stocks (represented by the Russell 2000) were the weakest sector in 2020.  With a new year, we have new leadership as the small caps were the strongest in January.  Here is the performance of the main indexes for January.

 

There is an old Wall Street adage that January gives the direction for the full year.  If January is positive, there was a high probability that the year would be up.  This was historically measured by the Dow’s and S&P 500’s performance and is called the January Barometer.

Data in recent years is questioning the strength of this relationship.  According to LPL Financial (February 1, 2021), 8 out of the last 9 times that the S&P 500 was lower in January, the index was higher over the 11 remaining months.  However, there might be a different result from a red January.  Volatility spiked in recent years that had a down January which is an obvious and expected outcome for 2021 given the country’s divide.

The economic and social landscape is at an unstable point.  The established elites will fight to maintain their position and power.  Given the progress of the Redditors, the individual investor doesn’t seem likely to backdown.  This situation as well as the issues facing our country will likely intensify rather than go away.  Perhaps this can be summarized as the banks and their colleagues are too big and important to fail and the individual is too small and insignificant to succeed.

 

 

[i] Stephen Still, 1966

[ii] The Washington Examiner, January 28, 2021

 

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA

Newsletter

December 21, 2020 – DJIA = 30,179 – S&P 500 = 3,709– Nasdaq = 12,755

“O Little Town of Bethlehem, How Still We See Thee Lie.”

 

This year has been one of intersections.  Tectonic and life altering collisions of dire events have changed the world.  The challenges that we are facing will impact our lives for many years.  While there is widespread hope and belief that we return to the lifestyle of pre-pandemic society, this is becoming less likely as time passes.  The unexpected outcome might be that 2021 is worse than 2020

Our turbulent year is ending with another historic intersection and, fortunately, this one doesn’t appear to be a disastrous pit.  The “conjunction” of Jupiter and Saturn in the Earth’s December sky is a different type of intersection and, who knows, it might signal an inflection point for the better.

A planetary conjunction is when two heavenly bodies seemingly meet as seen from Earth.   While the conjunction of our solar system’s two largest planets happens around every 20 years, they rarely pass as close to each other as they will this year.  Also, this year’s occurrence is notable as it is easily seen without a telescope.

This year’s astronomical intersection is being referred to as a “great conjunction” because the planets seldom appear this close to each other.  The orbits of Jupiter and Saturn do regularly intersect as viewed from our planet, but it is not as close or as bright as what is happening now.  The last time Jupiter and Saturn appeared so close and was so visible was March 1226.

Because of their infrequence, some scientists look for historic events surrounding “great conjunctions”.  Johannes Kepler was a 17^th century astronomer and mathematician who was a big influence on others such as Isaac Newton.  Kepler researched the possibility of a “great conjunction” being the Star of Bethlehem that guided the Three Wise Men as described in St. Matthew’s Gospel.  He concluded that there was a “great conjunction” around 7 B.C.

In addition to our cosmological excitement, the stock market has also acted celestial.  Stocks had one of their best months ever in November. The Dow Jones Industrial Average recently traded over 30,000 and the Nasdaq Composite has been on a moon ride and is up over 40% in 2020.  All the major averages are in record territory.

These gains contrast with the earthly background of the U.S. economy.  It is a huge contradiction that we have stock market records along with shutdowns and restrictions, high unemployment, and the destruction of small businesses.  However, perception is reality in the financial markets and computer algorithms do not typically look at the fundamental data.  They are more concerned with things like price action which can be a self-fulfilling circle.

Here are the major averages year-to-date performance as of December 18^th.

 

The declining value of the U.S. dollar has been a boost to the stock market.  The dollar index (symbol = DXY) is down 7.9% year-to-date.  More importantly, it is down 12.6% since the peak in March.  While a low double digit drop doesn’t seem like a lot, the dollar has a wide-ranging global impact.  It has a much greater force on other economic factors and markets than its absolute movement against other currencies.

The 120-day correlation between the DXY and the S&P 500 has decreased to a negative 88%.  Statistical correlations range between 1 and -1.  A correlation of 1 means that the two factors move together relatively and directionally.  The negative 1 would mean that the factors move in opposite directions.  At -.88, the DXY has clearly helped the stock market.

The factors weighing on the U.S. dollar are many.  The United States is over $27 trillion in debt. Further, there is well over $100 trillion of debt and unfunded liabilities.  While there are other countries in similar or worse fiscal conditions, the global capital markets may be losing confidence in the American situation.  This devaluation of the U.S. dollar is helping financial assets – for the time being.

Another shining star in the financial markets is Bitcoin.  The crypto currency is up 121% in the 4^th quarter and 228% year-to-date.  Again, this trade has an anti-dollar component, so the dollar’s slide has supported Bitcoin.  Here is a chart Bitcoin’s price for 2020’s 4^th quarter.

 

 

Confidence in the crypto currencies is increasing for some of the same reasons that the dollar is falling.  Out of control government spending, record deficits, and no plan to address these issues.  Nothing travels in a straight line, but if the dollar falls further, stocks and Bitcoin could keep rising even as the societal shutdown continues.

In a year full of historic developments, our solar system reminds us there is consistency of heavenly cycles.  This is in sharp contrast to the chaos that has overcome our lives.  If this “great conjunction” marks a change in our world, hopefully it brings a shift to healing, peace and an honest, truthful effort of moving humanity closer to a heavenly nature.

Merry Christmas, Happy Holidays, and Best Wishes in the New Year.

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA

Newsletter

–

October 26, 2020 – DJIA = 28,335 – S&P 500 = 3,465 – Nasdaq = 11,548

–

“You can look around and there’s not a sign of hypocrisy. Nothing but sincerity as far as the eye can see.”

One of the highlights of October is Halloween.  A time of the year when deception and trickery is encouraged.  Of course, if you are in politics, trickery is not just limited to the end of the October – it’s an everyday event.  And with this being an election year (what else would you expect from 2020!), the shenanigans have increased exponentially.

Naturally, the financial markets also have their level of chicanery.  Stock prices are near record highs while Main Street struggles, small businesses try to stay afloat, and the unemployment numbers remain stuck at uncomfortable levels.   Many are counting on a “V” shaped economic recovery and anything different could be a material disappointment.

In addition to the economic troubles, another mystery involves the market’s rally given the massive cultural division, civil unrest, and the uncertainty over the election.  Turmoil and doubt about the county’s future path would often result in volatile markets and a move to safety.  Currently, however, that doesn’t appear to be the case.  Rather, the capital markets are driven by optimism that the stimulus packages and economic bailouts will save the day.

Stocks are not the only asset class that is masquerading.  There was a time when bonds were considered a boring but safe investment.  But thanks to central banks’ intervention, they no longer fit that description. Interest rates across the markets are down to inconceivable levels.  The 10-year Treasury note closed last week (October 23^rd) with a yield of 0.84% which is up from a recent yield of 0.71%.  The 30-year bond closed at 1.64%   This means that to receive an interest rate of 3 or 4%, investors must get creative or assume a lot more risk.

Instead of offering investors interest payments, many of today’s fixed income securities exchange hands with negative yields.  In other words, the price of the bond (the price that it is traded at after it has been issued) is so high that the interest payments don’t offset the premium paid.  The total return is negative.

The European Central Bank, the Bank of Japan, and other central banks buy bonds in the secondary market as a stimulus tool  This massive demand forces prices higher and the result is that the higher price outweighs the interest rate received – a negative yield.  With central banks cornering the fixed income markets, those who are forced to buy bond (fixed income mutual funds, insurance companies, etc.) must overpay for the securities they need.

The graph below shows the total amount of bonds (as measured in U.S. dollars) that have negative yields. After a drop in the amount of negative yielding bonds in the spring, we are again approaching record levels.  Massive stimulus, which includes central banks (the Federal Reserve) buying bonds to save the economy, is the chief reason behind this.

 

With so much of the world’s bonds trading at prices that result in negative interest rates, fixed income securities are massively mispriced.  This impacts many other sectors of the financial markets as fixed income securities can no longer offer lower risk.  This forces conservative capital to move somewhere else.  Which then causes imbalances in other markets.

An example of this rippled distortion is the high number of zombie companies.  A zombie company is a highly leveraged, unprofitable organization that uses the bond market as a source of cash and capital.  Unfortunately, these zombies, if they can get funding, survive past Halloween.

Under normal conditions, these companies would go out of business because a lack of profits and additional funding.  Central bank manipulation and bond buying injects money into the markets which eventually reaches the riskiest sectors including the zombies.  Without this liquidity, they would fail.  That wouldn’t be all bad as their demise would reward the zombies’ profitable competitors which would strengthen the economy with higher growth rates.

 

 

Along with Halloween, it is also earnings season.  This raises the question of which one will be scarier.  The quarterly results, in general, have been good but the stock market’s reaction has not reflected these earnings reports.  The major stock averages declined last week as spooked investors were more concerned the possibility of an increase in Covid-19 and delays in the getting another round of stimulus approved.  Given that a lot of the economy remained constricted or shutdown, the better than expected corporate earnings could be an encouraging sign for a continued recovery.

Here is where the major averages closed on October 23^rd.

 

Everyone is aware of the Great Pumpkin’s reputation of only visiting sincere places so clearly, the corner of Wall and Broad Streets and Washington D.C. won’t be on the itinerary.  However, like the Great Pumpkin’s mystical power, there might be a larger force behind the stock and bond markets peculiar ability to remain higher as the world is crumbling.

Modern Monetary Theory (MMT) is a controversial approach that might be the driving force behind the capital markets.  First, MMT uses fiscal policy to impact the economy.  It calls for printing unlimited amounts of money and giving to the federal government to spend.  Budget deficits, according to this, are not a concern.  The only risk is inflation.  But if that happens, taxes are raised, and this is supposed to slow demand and eventually calm inflation.

One of the first to embrace MMT was Bernie Sanders as he included it as his economic policy for his latest presidential campaign.  It was the cornerstone as the method of financing the expansive social programs that he was to implement.  Outside of Sanders’ supporters, MMT has been widely criticized and disparaged by traditional economists.

Difficult times call for desperate decisions and it sure looks like the Federal Reserve and the Federal Government borrowed Bernie’s playbook in battling the economic shutdown.  During 2020 we have printed a lot of money and expanded the Federal Governments deficit to unimaginable levels.

A measurement of the money that is in circulation is the Federal Reserve’s balance sheet.  The Treasury Department may print the currency, but the Fed puts the money into the banking system.  This distribution process puts the dollar bills on the Fed books.

Below is a graph of assets held by the Fed.  To be clear, these ‘assets’ were bought by the dollars the Fed put into the banking system so money supply is the other side of the ledger.  Before the financial crisis on 2008-09, these assets totaled less than $1 trillion.  This quickly quadrupled to over $4 trillion by 2014 through the countless QE programs.

The Fed attempted to normalize monetary policy and return their balance sheet to more traditional levels in 2018 and 2019.  However, the bailouts, PPP, and various stimulus programs have pushed the total of assets held at the Fed to the current heights.  Of course, the Federal Government’s budget deficit will be equally astounding which gives the current situation all the markings of Modern Monetary Theory.

 

 

As measured solely by the rebound of the financial markets and the economy, so far so good.  This incredible amount of liquidity injected into the economy has certainly helped in pushing up the financial markets.  And until there some signs of inflation, central bankers have little appetite to turn off the printing presses.

However, there is typically some unintended consequences when untested theories are put into place.  It’s not being discussed but there is risk that inflation isn’t brought under control as easily as predicted.  Further, history has shown that high growth in the money supply causes bubbles to arise.  The downside to MMT aren’t limited to these goblins as there are many other dangers that could develop.  We must remember, there’s no free lunch.

In the meantime, whether Bernie Sanders gets credit or not, further increases in stock prices and financial assets could be in the future.  This economic trick or treat could keep going until everyone fills their bags with candy.  But like believing in the Great Pumpkin, as long as there is confidence in the Fed’s ability to deliver, the system carries on with only Charlie Brown getting the rocks.

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA

Newsletter

August 24, 2020 – DJIA = 27,930 – S&P 500 = 3,397 – Nasdaq = 11,311

i

“We the People of the United States…”

 

The battle between individual freedom and the public good is rarely at rest.  But in 2020, of course, this friction has erupted into an out of control, five alarm fire.  An economic shutdown and quarantine requirements were enforced as government officials accessed the situation.  It’s unclear what risk analysis was undertaken but it’s unmistakable that individual freedoms were sacrificed for the public good.

As the world tried to navigate the pandemic, the daily count of cases and deaths was the focus.  This is a direct and easy to understand measurement.  Other costs of the shutdown are harder to quantify and they were not widely discussed.  In economic terms, GDP might be an acceptable approximation.  But looking at the cost in terms of increased mental illness, abuse, depression, and suicide has not been widely examined.  Granted, these are complicated, but they were clearly deemphasized.

The lack of balance between the individual and the state combined with the historic social division and an economic shutdown has resulted in extraordinary times and unprecedented uncertainty.  A logical person would conclude the capital markets were in chaos.

In fact, it’s been the opposite.  The Dow Jones Industrial Average and the S&P 500 just finished their best 100 days since 1933.  It is the best 100 day move for the Nasdaq Composite since 2000.  The Dow and S&P 500 are both up over 50% during this time while the Nasdaq has jumped over 60%.

Of course, there was an equally historic plunge preceding this surge.  As stocks have returned to record levels, it is easy to forget the pain of late February into March.  The S&P 500 dropped 34% in 5 weeks.  The day after what subsequently became the bottom in the stock market (March 24^th), The Wall Street Journal’s headline declared “Markets Melt Down at Fastest Pace Ever”.

What a ride is has been!  Putting these developments into a picture, below is a chart of the S&P 500 for the past 12 months.

 

S&P 500 closed last week at a record high and it was the 4^th consecutive week of advancing.  Here are the year-to-date returns for the major averages as of August 21^st.

 

The bounce from the March lows has been momentous but also selective.  Large cap technology stocks (Nasdaq) have been the big winners with Apple, Amazon, Facebook, Microsoft and Google responsible for most of the lifting.  Apple recently became the first company to reach a $2 trillion valuation.

The narrowness of the rally is also shown in the difference between the performance of the Nasdaq Composite and the S&P 500.  The Nasdaq had outperformed the S&P 500 by over 25 percentage points.  While there is overlap within the composition of both indexes, especially among the largest companies, S&P has less concentration in technology and consequently it is lagging the Nasdaq.  The Russell 2000, which is mostly smaller companies, is trailing the Nasdaq by over 33 percentage points.

As wide as the gap is between the Nasdaq and Russell, it’s nothing compared to the abyss between Wall Street and Main Street.  While the Nasdaq has made over 30 record highs, much of the economy is straining to stay afloat.

Stores and restaurants form the foundation of Main Street and they have been destroyed by the shutdown.  Retailing and operating a restaurant are difficult ventures in a good economy but are exponentially harder now.  Aaron Allen & Associates, industry consultants, expect 35% of U.S restaurants to permanently close.

It’s a similar story for retailers as many have filed bankruptcy.  Some of the iconic names are J.C. Penney, Lord + Taylor, J. Crew, Brooks Brothers, and Modell’s.  Including all businesses, 2020 is seeing record bankruptcies.  Below is a chart with the number of companies filing this year through August 9^th.  2020 trails 2010 but this year could easily exceed the record as forbearances end.

 

With record unemployment and economic uncertainty, consumers could reduce spending habits for an extended period.  The pain would travel past stores and eateries to such things as cars, travel, and entertainment.  As a reminder, our pre-Covid economy was highly dependent on consumption and a timid consumer would hurt any recovery.

As a possible sign of things to come, here is a chart that compares the unemployment rate with the delinquency rate on consumer loans.  The data covers over 50 years and there is a material correlation between the two.  Consumer loans include loans such as personal, car, home equity, and property improvement.

 

 

This brings us back to the seemingly universal question, why is the stock market doing well when everything is so bad.  A partial explanation is the confidence in a quick and strong recovery after the shutdown ends.  This might happen but it gets more priced in every day that stocks rise as the shutdown lingers.  This could result in disappointment if we don’t rebound or do get a second wave of the virus.

Another important boost for the capital markets is the Fed.  Besides the stimulus programs by the federal government, the Fed has been active in the bond market by buying bonds and providing systemic liquidity.

Some indicators of their involvement are the money supply and the size of their balance sheet.  The money supply has expanded by 62% in the past 3 months and 78% in the past 6 months.  Their balance sheet (a sign of how big their programs are) has grown from $3.8 trillion to $6.2 trillion in the past 5 months.  They have used a lot of ammunition to support the economy.

The Federal Reserve can print money, and this is an important tool.  The markets understand it and have responded by rising.  There will be unintended consequences but Jerome Powell and staff are willing to take that chance.  If investors remain confident in their abilities, the markets will continue to behave.  On the other hand, any doubts by Mr. Market will be tumultuous.

Whether designed or not, 2020 has produced a series of events that have disrupted society and appear to be threatening the foundation of the United States.  Censorship vs. freedom of speech, economic authoritarianism vs. opening the economy, and Democrats vs. Republicans to name a few.  Our country has survived other chaotic situations and frenzied challenges.  It’s a good bet that we do it again.  The markets are counting on it.

 

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA

Newsletter

 

June 29, 2020 – DJIA = 25,015 – S&P 500 = 3,009 – Nasdaq = 9,757

“Ignorance is Bliss”

 

According to the stock market, there isn’t much to worry about.  Equities in the U.S. have rebounded from the nasty pandemic selloff and are sending a signal that the economy has returned to the road of stability and growth.

On the other hand, according to the headlines, there isn’t much not to worry about.  Social division, conflict, and turmoil dominate our existence. Add to this the economic shutdowns, historic unemployment, and widespread rioting and we get a different story than that of the upbeat stock market.

Logic would suggest that these opposing worlds cannot diverge forever.   The equity markets trade as if humanity has risen to a utopian state.  This is happening while society faces countless challenges and uncertainties as we adjust to a vastly different way of life.  Never have we encounter so many cultural unknowns.  Either our society and economy regain the vitality of past couple of years or stock prices need to retreat.

As far as achieving an idyllic cultural condition, some may already have.   With enhanced unemployment benefits, one-time stimulus checks, mortgage forbearance, and suspended car and credit card payments, workers are being paid for staying home while having their financial commitments suspended.

Below is a chart showing the number of weekly unemployment claims.  Everyone knows that a lot of people are out of work, but this picture is worth a thousand words.  It illustrates how remarkable the situation is.  Continued weekly claims filed reached 25 million in June which is 5 times the peak in the last financial crisis.  Continuing claims or those filing for unemployment each week remains at around 20 million.

 

 

Here is a related chart showing the amount of stimulus money households received in April.  The total is $3.12 trillion dollars.  Again, we know the Treasury sent out a lot of stimulus, but this shows how astounding that amount is.  There has never been anything close to this level of assistance.

 

These numbers paint a picture of what is happening on Main Street.  It is gravely different from the stock market’s view.  Hopefully, the job market and the general economy begin to improve as businesses re-open.  In other words, the much predicted “V” shaped bounce.   However, given the severity of unemployment, there is a much to recover.  Also, there is risk of a day of reckoning with some portion of stimulus recipients that must start making mortgage, car, and credit card payments when the super-sized stimulus ends.

In the meantime, the stock market is making a bet that everything ends well.  Of course, plan “B” centers on the Federal Reserve.  Our central bank has played enormous role in supporting the stock and bond markets.  They have been buying all forms of debt which has injected enormous liquidity through all markets.

While they haven’t admitted to directly buying any stocks, equities have visibly benefited. Below is a table of the year-to-date returns as of June 26^th.

 

Large caps and technology sectors have been the best performers.  The Nasdaq is making new all-time highs while the S&P and Dow have trimmed their losses.  Small caps continue to lag.

There is even further concentration within the winning sectors.  As of the middle of June, three stocks accounted for 89% if the S&P 500’s returns.  Amazon, Apple, and Microsoft have combined to provide an incredible amount lifting within the stock market.  Owning or not owning these three stocks has made a huge difference in 2020.

Another revealing statistic is the fact that only 150 stocks in the S&P 500 were up YTD.  With 70% of the stocks declining for the year, it is remarkable that the S&P 500 is only down single digits.  Once again, this demonstrates the performance power of Amazon, Apple, and Microsoft.

One large headwind facing stocks is the decline of profitability.  Below is a chart showing the value of the stock market and the amount of corporate profits.  As shown, there is a high correlation between profits and equity prices.  A divergence began around 2016 and has widened in 2020.  Despite the Fed’s involvement in the markets it is hard to imagine this continuing.  Once again, profits need to catch up to stock prices or equities will retreat toward profits.

 

The conflicting messages being sent by Main Street and Wall Street are a mystery.  An economy that includes historic numbers of people getting paid not to produce (many incidences getting more money to stay home than they made while employed) is normally a troubling sign.  Add to this a cultural civil war and a break down of moral standards.  It is remarkable that the markets are functioning at all.

As the financial markets have stabilized and rebounded, it communicates a belief that these problems are temporary.  Further it says that the recovery will be speedy and complete.  And if for some unknown reason it doesn’t work out that way, the Federal Reserve will save the day.   The biggest risk is that of record high stock prices.

The pandemic has impacted our lives in countless ways.  One interesting thing at is relates to the stock market is the arrival of those who previously gambled on sports and at casinos.   The popularity of the Robinhood app (and its free trading) has drawn in this new group of ‘investors’.  It is largely comprised of people trading stocks for the first time.  This inexperienced gang have caught the stock market recovery and have made money.  Let’s hope they understand that stocks move both ways.

The ability to connect the economic and cultural realities to the financial markets might be a challenge for some.  History has shown that there is a definite connection between the two.  But, as the old Wall Street saying goes, “Don’t confuse brains with a bull market”.