Skip to content
Blog Hero Image

Posted by Greg Taylor on Jun 2nd, 2020

Three things to live by in the current market

With many stuck at home and sports on the sidelines due to the pandemic, it seems like trading the market has become the new pastime. Self-directed investing platforms such as Robinhood have reported that record new account openings and odd-lot options trading are at a new high.  After many years in which it felt like more people would rather talk about their real estate investments than stocks, this is a big change.

Overall, this shift should be looked at as a positive. It’s also a good time to remind investors of some of the long-standing realities of the stock market and put them in context of this current rally.

One of the most important facts investors need to remember is that the stock market isn’t the economy. It’s very important to look at what makes up the stock market to understand why it’s acting the way it is. For example, the S&P 500 now includes 5 mega-cap technology companies which represent roughly 20% of the index. On the other hand, the small-to-medium businesses that have taken the brunt of the impact of the mandated lockdown are a tiny portion of the index.

In the last few months, across almost all sectors, the big have gotten stronger and the small have gotten weaker. As choices were taken away from shoppers, more commerce shifted towards those retailers deemed essential or available online, giving them an advantage over their competition and propelling their share prices higher. As their effect on the index is much larger, this can mask underlying issues in a segment that makes up a big part of the economy but a small portion of the stock market.

Another common feature is how markets tend to climb a wall of worry. How many times over the last month did you hear questions along the lines of, “why is the stock market rebounding so fast even though the economic data is so bad?” While markets have always been forward-looking and tend to turn ahead of good (or bad) news, what we are seeing in today’s market does look like one of the more vivid examples of looking over the valley. Every week we have been witnessing record high levels of unemployment and job losses, but the market marches higher.

The simple explanation for this is that nobody was expecting the numbers to be so relatively positive in the face of a wide-sweeping economic shutdown. The bad news was already in the stock market. What moves markets is seeing something unexpected. It’s all about the second derivative now. We know things are bad, but are they worse than expected or getting better? As long as the economic data isn’t worse than already record-low expectations, the data will largely be ignored as something we already knew.

The major lesson that all investors should take from the experience of the last few months is don’t fight the Fed. In contrast to other times of economic stress when central banks have been criticized for acting too slowly, this time the Federal Reserve must be commended for doing everything it can in a very proactive manner to calm markets and the economy. As the markets entered freefall in March, global central banks slashed interest rates to zero and launched quantitative easing programs bigger than those from the global financial crisis. This time, the actions have included directly buying publicly traded ETFs of investment grade bonds.

With rates at zero and central banks buying, markets will have a hard time going down. The markets have absorbed record levels of investment-grade bond issuances, giving valuable funding to stressed businesses, which has tightened credit spreads and supported the underlying equities. When the Fed is actively buying bonds, is it really the best plan to short them?

On the month, markets continued their run off the March lows with another strong performance. After falling over 37%, the S&P/TSX is now only off by 11.2% on the year, while the Nasdaq is positive and the S&P500 is down 6.5%. In the month, we may have started to see a broadening out of the rally as lagging sectors, such as banks, joined in the party, while some of the early winners in technology and gold have paused. Whether this is a signal of the end of the bounce or the start of the next push higher in indices remains to be seen.

By the numbers as at May 31, 2020.

Given the “realities” of the market all seem to be pointing higher, what are the risks? Narrow leadership makes the overall market very risky if something negative were to affect the few winners, which could come in the form of a renewed China-US trade war or legislation to take away perceived advantages. The other risk would be if doubt around the timing of the recovery emerges. The market is now expecting a V-shaped economic recovery, with spending and employment back towards normal by the Fall.

The biggest risk could also be seen as the most unlikely – a reversal in action by the central banks. Their commentary has been extremely cautious about removing stimulus too soon and, in an election year in the US, this risk appears even more remote for the Fed. Any change to commentary from the central banks could be seen as a major risk, though that seems unlikely in the near term. Until these events occur, the path forward appears higher, maybe not always in a straight line or at the pace of the last few months, but for those sitting out the rally, the pain trade is higher and will keep dragging them back towards the market.

— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments

All data sourced from Bloomberg unless otherwise noted. By the numbers displays total returns for the month of May, 2020.

The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.

Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

Greg Taylor, CFA

Greg Taylor is the Chief Investment Officer of Purpose Investments. A data-driven manager with a focus on managing risk through active-trading strategies, Greg specializes in finding and exploiting pockets of volatility in the market to drive returns. He spent more than 15 years managing pension and mutual fund assets at Aurion Capital Management. He also held a role of senior portfolio manager at Front Street Capital and LOGiQ Asset Management before coming to Purpose Investments.