5 Reasons To Be Cautious In This Market
If you are not trained in the world of finance, Wall Street can be an intimidating place. Like most industries, the stock market is full of jargon and parlance. The cynical might say such language was designed to confuse and obfuscate.
It need not be that way. While there are certain complexities that require education and experience, most often common sense and, in our opinion, a consistently applied strategy is enough to get you by when managing your portfolio.
With the world swirling amidst a global pandemic, economic recession, and civil unrest, stocks are now back to levels seen prior to all these problems surfacing.
It’s a good time to ask if this makes any sense…
Prior to the Covid-19 crisis erupting in March, the market was trading at levels we believed to be on the high end of fair value based on earnings estimates at that time and the overall outlook for the economy.
However, employment was at record levels and getting better each and every month.
High stock prices were further supported by lowered tensions with China and a Federal Reserve that was resoundingly on the sidelines in terms of hiking interest rates—the so-called Fed put that you may have heard about was thought to provide support.
It was smooth sailing, indeed.
Flash forward a few short months, and much has changed. Economic conditions that were present in the early part of the year are no longer in place, but at current prices the market is telling us nothing has changed; there are no added risks to the economy or the outlook for earnings.
We don’t agree with the current consensus and, as such, we are more cautious than we were in January and February.
Here are 5 reasons to be cautious:
China Tensions Return
Ground zero for Covid-19 is in Wuhan, China.
Did China tell the world everything it should have about this dangerous new disease? In America, the President openly challenged China, going so far as to blame them for allowing the virus to escape and encircle the planet.
Will the U.S. demand reparations? Mere talk of such a possibility increases the risk of an economic battle; likely something greater than the last go around.
The potential for a real calamity caused by the sparring of two economic behemoths is reason enough to be cautious on the market at this stage.
Unemployment is a Sticky Wicket
One of the more aggravating aspects of the recovery from the depths of the financial crisis in 2008 was wage stagnation. Despite record low unemployment, wages were stuck in neutral for a long time, but that was beginning to change at the start of 2020.
In the early part of the year we started seeing signs that wages were on the cusp of meaningful gains. That makes sense when unemployment ran at such a low rate.
Covid-19 changed that in a hurry. One can forget about wage pressures when unemployment now stands at more than 13%.
We still don’t know the full extent of damage caused by the sudden slamming of the economic brakes. Our concern is the effect on small businesses where a lot of this new unemployment came from. The slow pace of reopening can only compound the problem. We won’t know the total damage in terms of rehiring plans and bankruptcies until we’re further down the road.
Another reason to be cautious on this market.
Large Company Investment Remains Uncertain
When the economic skies are cloudy, businesses become cautious with investments and capital spending. Small business may be critical in terms of employment across the country, but large company spending is a critical component of economic growth.
Large business spending plans for 2020 were cut dramatically as the lockdowns commenced. According to the Bureau of Economic Research, the United States economy plunged into recession in February. Until the recession ends, we can expect large companies to remain cautious with their spending plans.
We think you should do the same with your portfolio.
The Future Depends on the Consumer
According to the White House Council of Economic Advisers, the consumer accounts for 68% of GDP. The lockdown’s impact on consumer spending is why we’re in recession today. While we can expect a burst of spending once all states fully reopen, we expect consumers to remain cautious.
To the extent unemployment remains in double digits, consumers will not have the firepower to return to spending at levels seen before the crisis.
At current levels, the market is ignoring this risk
A Second Wave of Covid-19 Could be Worse than the First
Universal opinion of epidemiologists says a second wave of Covid-19 is coming, most likely starting this fall. What is not known is how severe that second wave will be.
Will there be another lockdown?
We are not sure how the market can assess this risk when we don’t even know the full extent of the ongoing damage caused by the first wave.
The good news is that the global community is much more informed about Covid-19 and better prepared to deal with its ramifications. Still serious issues arising from a second wave remains a real risk.
To embrace this market at these levels, one would have to dismiss all of these risks on economic growth and future corporate earnings.
That’s not using common sense.
If you would like to discuss our views on the economy today and current market conditions and how it all impacts your personal situation, please give us a call.