Both Pedals to the Metal

Published at Sep 9, 2019, 12:00 AM in wealth management by Dr. Brad Klontz

“I pretty much try to stay in a constant state of confusion just because of the expression it leaves on my face.” Johnny Depp

“The monotony and solitude of a quiet life stimulate the creative mind.” Albert Einstein

I would like to start by apologizing for not writing my newsletters lately in their usual quarterly frequency. This has been an unusual year for many reasons, one of which is the time I have spent finishing my first book titled “Stop Overspending.” I am lucky enough to be asked the reason for my silence on the newsletter front, and this is one reason why. I will send a link to it once published, which is going to be in the next few months, and I hope you’ll enjoy reading it.

We are in an election year, at the tail end of a vulnerable 11-year economic growth cycle and an aging equity bull market, shaken by a pandemic and full of environmental disasters. It is extremely difficult to make a sense of it from a market analysis point of view as it is full of unprecedented events. If we can’t compare a data point against historical trends, what we’re left with is speculation and guesswork.

The list of events that start with the phrase “first time in history” is quite long. We have never seen the global economy and markets voluntarily shut off as swiftly as it was, for a common reason that is shared globally. Similarly, the fiscal and monetary response to this has also been unprecedented. The FED, having learned valuable lessons from the 2008 Global Financial Crisis, swiftly came to an aide, and the first time in history, purchased corporate credit to keep the bond market alive and functioning. The 33% US Gross Domestic Product drop in the second quarter, was among many unprecedented adverse economic consequences of Covid-19.

The stock markets around the globe reacted with a waterfall decline which only took 24 trading days to the bottom in the US. To gain a context, compare that to the Nasdaq tech bubble in 2002 and 2008 Global Financial Crisis, both of which took approximately 2 years to unfold.

After a few months of the Covid-19 induced economic collapse, April marked the bottom of it and so far, we have been seeing a V-shaped economic and market recovery in the US. The FED announced that the damage has been half of the initial estimates. As popularly expressed, the shape of the economic recovery, whether V, U, L, or W shaped, typically starts to form/differentiate approximately 4-5 months after the bottom is seen. In other words, the turn the economy is about to take in the next few months carries the potential to determine the overall shape of the recovery. As a result, market participants (including yours truly) are trying to figure out what next is about to unfold. Whatever happens, will likely happen with speed and volatility. These days, because of algorithmic trading and more widely used Exchange Traded Funds, what used to be once in a lifetime events such as circuit braking market moves, can be seen twice in a week.

The golden rule we all memorized after 2008 is, don’t fight the FED. Now, we can revise it and add the word “globally” somewhere in that phrase. When a total of $15 trillion is being injected in the global economy, and there is surely more to come, how bad can things turn out?

On the flip side, most data show an expensive stock market and a nervous consumer, usually not a good combination. Some people point out that we’ve only recovered roughly half of the economic fallout and there is more growth to come, a likely reason for the strong recovery in the major stock indexes. Others rightfully bring our attention to how narrow the recovery has been, simply isolated to large US growth stocks and tech giants. If you remove these two parts from the equity habitat, you’ll be left with a much less promising picture.

In summary, current conditions give signals that create faces like Johnny Depp’s, and rightfully so. Let’s look at some of this data.

The US unemployment rate prior to the Covid-19 pandemic was around 3%, which is considered as full employment. Within a matter of weeks, it jumped over to 14% and it’s now down to 8.4%. So, on the employment front, half of the damage is recovered. To those who don’t believe in the economic recovery, I suggest they look at the Purchasing Managers Indexes (PMI). A recent reading came from The Markit Flash US Manufacturing PMI at 53.5 (above 50 indicates growth), its highest level since the beginning of 2019. In English, the manufacturing sector is growing at its fastest paste in the last 18 months. When we look at services, the bigger of the two, it is at 54.6, even better. These numbers, accompanied by historically low interest and inflation rates, should translate into business optimism but because of uncertainty caused by the upcoming elections and the future possible developments in the Covid-19 pandemic, we don’t see it this time around. Speaking of low interest rates, we would be remiss if record level mortgage applications and the spike in the new and existing home purchases, as a result, weren’t mentioned here.

To the economic fallout, the fiscal response so far has been a $3 trillion stimulus package, and we know more is on the way, somewhere close to another $2 trillion. How big are these numbers? Let me put it this way: the total cost of the 20 years of war in Afghanistan and Iraq, is $3 trillion, which is now spent in a matter of months. That big…

The stock market waterfall decline was followed by the quickest recovery on record. The Dow Jones Industrial’s average bottom to new-high recovery speed is 48.6 months (Source: NDR). So, it’s roughly about 4 years. Current recovery speed? 5 months, from the end of March to mid-Aug!

That’s the pedal to the metal type of good news, but here is the catch: the current SP 500 forward price-earnings ratio (valuation measure) is only matched by the figure in 2000, which was followed by the famous tech bubble bursting bear market. That’s one reason why the breaks should be kept close by.

Should we then overweight bonds? Well, here is another first time in history type of an event, the US real interest rates went negative. So actually, compared to bonds, stocks are cheap, even with the above-stated valuations. So, should we then overweight stocks? Well, the stock market may easily reverse gears and start a W shaped trend if the market breadth (how wide the recovery is) doesn’t improve any time soon. As mentioned before, only a small number of stocks are carrying the weight. Not an easy decision to make between the two, stocks and bonds.

As I am typing these lines away in the historically weakest month of the year for the stocks (Sept), I am also getting ready to watch the first presidential debate. Stocks on average close the election year with losses if the republican incumbent loses, and strong if the opposite materializes. In the year following the election year though, the complete opposite is true. The first year of a democratic president, stocks on average recover their losses and more but may show losses with a republican president. In short, if Trump wins, stocks may move higher for a few months and then lose steam. If Biden wins, we may see a downtrend till the end of March, and see a strong uptrend, if of course, history is our guide.

In the long run though, stocks perform the best with a democratic president and a split congress, 8% on average. A republican president and a split congress annual average performance is a loss of 4.7%. So, each scenario creates its winners and losers for the short and the long term.

In short, these days, I would keep my long-term objectives close to my chest, place one foot on the gas and the other on the breaks while some cash is stashed in the trunk to be able to maneuver in any direction, as the short and near term is quite murky.

With that, I wish you to stay above all safe and healthy, and away from the Covid-19 virus spreading in our communities.

Thank you for reading my newsletter. I hope you’ve found it a fun read and informative. Please feel free to reach me with questions and comments on