How many times have you heard people talk about the stock market in the last 6 months? It's probably been at least more than once, and in some cases, maybe more than ever before.
Imagine that in January 2020 you took a trip to a remote island that was totally off the grid. If you arrived back in the US today, you could probably see pretty quickly that a lot has changed. But the thing that may have changed the least, is the price of the stock market. On January 23rd, 2020 the S&P 500 was priced at $3,325. As I write this today on August 14th, 2020 the S&P 500 price is $3,371. If you never looked at what had happened over the prior 7 months that you were gone, you might come to the conclusion that this was a very uneventful year so far.
All of us that have been here for the events of 2020 have seen a lot. Personally, I feel like this year has gone on for a decade, it's crazy how much has happened. And when we look at the stock market, it's no different. At one point, we were down almost 40% on the S&P 500. FORTY PERCENT! That's wild! Since then, we have run all the way back up to our all time highs. It's been a historic run.
But what is that run up based off of? How did we get back up to these levels? How much higher can we go?
Unfortunately, I don't have all those answers, but what I do have are eyes and I have a couple of observations.
Back in March 2020, the Federal Reserve cut interest rates from about 1.5% down to 1%. Thirteen days later, the Fed cut rates again all the way to 0%.1 From the chart below, you can see that both of those cuts were unscheduled (not at a regular Fed meeting). At that point, there was a mad dash to refinance homes because 30 year mortgage rates were at some of the lowest levels historically.2 The Federal Reserve will do this for a number of reasons, but a main driver to to spur spending from consumers and lending from banks (banks can borrow money at low rates and "resell" that money to consumers and a little bit higher rates). What this also did was spur some people who may be waiting 1-2 years to buy a house to buy sooner because of the historically low rates. In the last few months I have had dozens of clients buying houses.
Twelve days after the March 15th 100 basis point (1%) rate cut, we had a historic stimulus package passed. And when I say historic, I mean there has never been as much money put into the economy at one time ever before - $2.4 TRILLION. As a comparison, in the Great Recession years ago, the largest stimulus package was $858 Billion. Over the entire 3 year period of the Great Recession, there was $2.8 Trillion pumped into the economy (see chart below). We did that in 3 months this year. The "a trillion here, a trillion there" quote below goes back to the 1960s when Senator Everett Dirksen famously said "a billion here, a billion there" and pretty soon you are talking about real money.
If you pump air into a balloon, it is going to inflate. The "economy", or should I say "stock market", is no different.
Here is what I also see. There are a lot of people who's careers are still flourishing. Many of my clients are having one of their best years yet. What I am starting to see now from many folks is that the end of year bonus' are starting to get cut, and 401(k) matching contributions are also starting to get cut. Many people rely on those extra dollars to help them get over the hump, and if they don't get those this year it may put them in a huge bind. That's why in my planning I try to treat those as extras. If we plan for what we control, then if there is more money from elsewhere (bonus, match, social security, inheritance, etc.) then the plan will still work!
Bankruptcies in the US are on the rise. Unemployment in the US is higher than almost any other time in history (there are a few exceptions i.e. 1929). Fortunately the job market is getting a tiny bit better, but the unemployment rate is much higher than in 2008. We need to understand that the stock market and the economy are two totally separate things. Just because the stock market is up, and looking good, does not mean the underlying fundamentals of the economy are looking as good. Remember how much stimulus was pumped into the economy on March, plus the back-to-back rate drops?
When we look at some of the largest companies in the US - Amazon, Apple, Google, Netflix, Microsoft, Facebook - this year has been incredibly generous to the value of those companies. Those 6 companies make up almost 25% of the ENTIRE S&P 500.3 Six companies are responsible for roughly 1/4th of the returns of the index, said differently, 499 other stocks (the S&P 500 is comprised of 505 stocks) make up about 75% of the gains.4 That is absurd. If it weren't for those six companies having the year they have had, the S&P 500 would be down, not up, for the year. If your portfolio has those 6 stocks, you are probably feeling pretty good. If you don't, you may have some of that FOMO kicking in right about now.
BE CAREFUL. Are you aware of the concept of gravity? What goes up must come down. There are many headwinds against those big tech companies - legally, socially, morally, and globally. This isn't to say that big tech won't still do well. I mean how can you bet against a $2 TRILLION company? Again, I reiterate - BE CAREFUL. Often times the attractive and exciting things in the investment world appear that way right before it gets crushed (i.e. bitcoin in 2017, dot com stocks in 1999, housing in 2007, tulips in 1637, etc).
If you have big gains, now may be a great time to diversify. When there is uncertainty on the horizon, stock markets reflect that with their price (i.e. COVID-19 uncertainty in February-March of this year). As we approach the election, expect uncertainty, expect volatility, and don't chase a stock just because your friend or colleague told you about it (look at the stories of how people lost everything doing that in the 2000s)
The Fear Of Missing Out is real. Everyone experiences those emotions, especially when everyone is bragging about how much money they are making. In many cases, they start taking bigger and bigger risks with their money because they see things in a vacuum. When those things happen that you never see coming, that's what gets people in trouble.
For my clients who are investing, we are diversified. When we see sectors have good years, we continue to diversify. If we don't, and we are too heavily-weighted in one sector of the economy, we expose ourselves to more volatility. And when we have more volatility, especially when we aren't expecting it, that leads to more fear and emotional decision-making. We also have to behave. Successful investors behave differently than the crowd. Volatility is your friend, especially when you are young.
Be patient, don't chase, and enjoy the ride!
Sources:
1 https://www.cnbc.com/2020/03/15/federal-reserve-cuts-rates-to-zero-and-launches-massive-700-billion-quantitative-easing-program.html
2 https://www.freddiemac.com/research/insight/20210305-refinance-trends
3 https://www.barrons.com/articles/big-tech-stocks-sp-500-51627312933
4 https://citywireusa.com/professional-buyer/news/just-five-stocks-have-driven-a-third-of-recent-sandp-500-returns/a1553780
Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit and inflation risk. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not guarantee profit or protect against market loss. S&P 500 Index is a market index generally considered representative of the stock market as a whole. The index focuses on the large-cap segment of the U.S. equities market. Indices are unmanaged, and one cannot invest directly in an index. Past performance is not a guarantee of future results.