Why Is The Stock Market Higher.

I think one of the hardest things for investors to understand is why stocks often rally in the face of bad news.  Most people's world view is made up by their perception of current events and what's going on in their daily lives.   Given everything that's been happening this past year,  it's easy to see how many carry a negative view of our times.   Investor's will often carry this pessimistic viewpoint over into financial markets.  However, markets work on a different logic as they discount future events  and trade accordingly.  The world is full of really depressing news right now, but the reason stocks have traded higher since last spring is because investors see through both Covid and our current political climate.  Investors believe that the worst of the pandemic will be behind us probably in the next few months.  They also believe that the disgraceful events of the mob that attacked the Capital last Wednesday will have little or no bearing on future economic growth.  Investors discount that event because they believe it will have no legs.

One of those old and famous Wall Street sayings is "buy at the sound of cannons, sell at the sound of trumpets".   Legend has it this phrase dates from the Battle of Waterloo and it would take up too much space today to tell that tale.  Yet, what it means is to buy equities when the news is the worst and sell when things are as jubilant as they could possibly be.  Each part of that discipline is hard.  Selling at a top is virtually impossible as both market highs and market lows are only known long after they have been made. Buying when the news is grim is hardest in my opinion because psychologically speaking everything that most investors see at that time tells you this is a horrible time to be investing.  Here though are some examples of when buying stocks made absolutely no sense to most investors, yet doing so has led to extraordinary financial gains.  

The first example goes back to World War II in the April-May period of 1942 as the Allies were getting militarily stomped all over the globe.  Soon though the Battle of Midway occurred and the complexion of the war changed.  Between then and the end of 1945 the Dow Jones Industrial Average returned on a price basis over 115%.  Here, I'll use the Dow in this example because the other indices then didn't exist.  Or take August of 1974.  Back then the economy's being pummeled by inflation, there's civil unrest due to among other things Watergate which results in Richard Nixon resigning as President.  The S&P 500 has also declined nearly 50% over the past 21 months at that point.  Yet buying then would net you nearly a 60% return over the next two years, much more if you'd held on longer.  Most of us still painfully remember the 2007-2009 financial crisis.  I often say the world only gets to end once but the 2007-09 period was the closest I've seen to the financial world unraveling.  Yet, if you bought in March of 2009 you are still reaping the rewards of that decision.  The S&P 500 is up over 450% since then, not including dividends. 

As the news last spring went from bad to worse and with both the markets and the economy tanking, I felt the risk/reward nature for investors had tilted substantially in their favor.  Market's were discounting at that point too much bad news, while not recognizing the positive responses that were likely to come forth from both business and governments.  I said the following as part of a larger note on this blog back then:

"Assuming, the disease doesn’t morph into something more deadly it is reasonable to expect pent up economic demand to start coursing through the system later this year and carry over into 2021.  If you buy my thinking on this then it is reasonable to assume that stocks have declined to much more attractive valuations if investors are willing to look out 12-18 months.  Investors with that type of time horizon and the willingness to assume more risk should think seriously about taking advantage of the opportunities because corporate America is for sale.  Now there’s a reason that stocks are so cheap given all the uncertainty out there.   But I say there’s value being created right now in the markets even as I’m telling you there’s some probability that stocks could fall further in the coming weeks.  I say markets are cheap knowing that the world is looking into a deep dark pit right now and nobody knows when we’ll starting digging our way out.  But we will dig our way out!  It is only a matter of time and sound policy before we start that process.  In that vein, I’m not very good at asking clients to send my firm additional dollars to invest but I will say that if you buy my line of reasoning then I’d suggest perhaps sending us some additional money to put to work on your behalf over time.  Better times will come just as winter turns to spring.  The seeds in the heroic work of our medical communities and the Federal government’s checkbook are being planted even if we can’t see any green shoots yet."

I penned that note to clients on March 22.  That turned out to be a correct judgement as markets moved almost in a straight line higher over the rest of the year.  Now obviously I didn't know how 2020 would end up back then.  In fact if you go read what I originally wrote you'll find I went on to warn there was a very real possibility for more pain in stocks before things settled out.  That part didn't occur.  Now in retrospect this looks like a great call in terms of market timing.  That is not the purpose of me writing this article.  One of the reasons I've always maintained a presence here is to have a record of the things I've written. My views last spring may have been correct in hindsight but I can point to many things I've posted over the years that were wrong and look foolish in retrospect.  If I'd been asked back then where I thought stocks might be by the end of the year then I'd have said perhaps slightly higher than where they were trading back in the spring.  I would have thought the real potential for appreciation would have come in 2021.  Since I am a long-term investor for client money I will always have a 6-18 month time horizon and given that view I felt equities were exhibiting enormous potential given the size of the decline back then.   I thought though we might need more time to see those investments become profitable.

Money will always go where it's treated best and right now investors believe there's going to be better treatment in terms of a return on their capital in equities.  That may turn out to be a fool's errand in the short run, but right now that's the view. Longer-term, in that 6-18 month window I use for investments I'm still pretty bullish on things.  Part of the reason for this upbeat view is the combination of government stimulus of which more is coming, an accommodative Federal Reserve and an economy that at some point this year is going to emerge from its locked down status.  The combination of these factors should lead to robust economic growth.  That, in turn,  should be good for equities.