People love a good narrative, whether they’re reading a book, watching a movie, or trading stocks.
Yes, it’s true, markets may be rational over the long term.
But we don’t live in the long term. We live in the now. And it’s traders, investors, fund managers, and algorithms programmed by humans that drive markets in the here and now.
That means the psychological impact of a narrative – that one big idea that makes sense of everything that’s happening, even if it doesn’t account for every little market wiggle along the way – STILL drives markets more than the perfect rationale of robotic logic.
Traders, investors, and money managers are influenced by narratives just like the rest of us – even if they don’t know that’s what is driving their decision making.
Right now, the big idea that overshadows everything else is simple…
There’s a lot to dislike about the way things are in the world right now, and lots of folks are using those as reasons to stay out of the market.
And it could mean losing out on a ton of profits. In fact, we’ve seen something like this before…
In early 2009, as the market began to recover from the financial crisis of the prior year, many investors stayed on the sidelines, waiting for the other shoe to drop and the market to take another dive.
As you can see, that never came to fruition. And those that hesitated missed out on the ground floor of the longest bull market in history.
And the same people who missed the 2009 rally will likely miss the big one that’s still to come.
But you don’t have to.
Similarly, countries all over Europe are facing the same Covid-19 surge and are going into another set of lockdowns. France, the UK, Spain, Italy, Belgium, Germany, Austria, and others all either just started or are about to start another set of lockdown-like rules.
Even the Central and Eastern European countries that managed to avoid the summer Covid-19 surge are being hit hard now. Poland, Hungary, and Czech Republic, for example, are both really struggling.
Here’s a chart of the rolling 7-day average of new Covid-19 cases for a bunch of countries, divided by millions of inhabitants so the size of the country doesn’t matter:
As you can see, pretty much every developed country is seeing a huge spike in new cases.
Basically, cases are exploding across the Americas, Europe, the Middle East, Russia, and Central Asia.
That’s a huge chunk of global GDP.
Many will say this alone is a reason why stock markets should be falling, not rallying.
But there’s more…
The “Other” Party Doing Well Doesn’t Mean Stocks Should Go Down
Even the most seasoned traders and investors can fall prey to the temptation to mix your investment with your politics.
What I mean is this. Maybe you like Trump, or Biden, or neither. Maybe you’d rather Republicans keep control of the Senate, or maybe you’d prefer Democrats to take it.
The thing is, with the stimulus narrative that is driving the market, now that we know the senate will almost certainly stay in the control of the Republicans, the presidential outcome will matter much less. Yes, some sectors will probably do better under Trump than under Biden, and vice versa.
We’ve already covered many of those here.
Some people say that Trump’s very competitive approach to trade and foreign policy will restrict global growth.
Others say that Biden’s income redistribution plans will kill the proverbial goose that lays the golden economic eggs.
There’s some truth to both. But Trump is not about to shut down all global trade. And Biden is not about to turn America into the Soviet Union.
Maybe on balance your preferred candidate is actually better for the economy. Even so, that doesn’t mean the economic world is going to end if the other guy wins.
Which brings me to the final mistake people are making…
The Stock Market is Not the Economy
2020 has surely made it clear that what stocks do and what the economy does can be two very different things.
As you can see in this chart, the S&P 500 (in blue) has recovered since the March crash even though unemployment (in red) is nowhere near where it was at the beginning of the year:
That in itself is the third reason people give for why this rally shouldn’t be happening and can’t last: “The stock market is completely disconnected from the economy,” they’ll say. Or, “This can’t last. Sooner or later, stocks will have to come crashing down.”
And as the employment chart shows, it’s true that the economic recovery has been modest, while stocks have rocketed to new all-time highs.
Here’s the thing.
Stocks are up for one very simple reason. It’s a reason that explains not only why stocks rise even as the economy recovers slowly…
Why stocks rise even though Covid-19 is surging…
And why stocks rise largely regardless of who’s winning the election.
It even shows why this rally will keep going…
It’s All About Stimulus, Stimulus, Stimulus
Here’s a chart of the S&P 500 this year again, but this time instead of the unemployment rate, the second line shows the Fed’s balance sheet (in green):
That green line, the Fed’s balance sheet, is one simple way of tracking just how much money the Fed has pumped into the economy.
The Fed has done this is by buying Treasury bonds and other financial assets from institutional investors. So if the Fed’s assets go up in value, that means the Fed has paid a corresponding amount of US dollars to the seller of the asset.
As you can see, the Fed’s balance sheet has gone up by about $3 trillion since the March lows.
That means the Fed has pumped about $3 trillion of stimulus into the markets. And it’s not done yet.
And that’s just the Fed. Congress has also been giving the economy stimulus (called fiscal stimulus, as opposed to the Fed’s monetary stimulus), through loans to companies, the $1,200 checks to individuals, the Payroll Protection Program, and many other ways.
But because restaurants, cafes, movie theaters, concerts, cruise lines, amusement parks, sports stadiums, and so much else is still closed, there are way fewer things to spend all this money on.
So this money ends up going into savings.
Here’s another chart of the S&P 500, this time graphed alongside the total amount of savings in U.S. banks shown in red:
As you can see, the market started going up pretty much exactly when the amount of savings skyrocketed. Those savings deposits are now about $2 trillion higher since March of this year.
That $2 trillion increase is the largely from the combined stimulus from the Fed and Congress happening when many people had fewer opportunities to spend it.
We’ve talked about why this sent markets up before. There’s little to spend this money on because of Covid-19, and with interest rates at rock bottom, neither bonds nor savings accounts won’t pay you anything on all this money.
The main place where this $2 trillion has any chance of growing is the stock market. So eventually this money finds its way there.
We were in a similar position in 2009 and 2010, just after the Great Financial Crisis. So many of my friends and family members didn’t get back into the stock market because they were waiting for the other shoe to drop.
After all, the global financial system had just halted, and if you looked out the window, the economy looked pretty bad.
Many market professionals I knew also kept waiting for another market crash, for the Great Recession to make a “double dip” and hit stocks again.
And so they missed the greatest bull market in U.S. market history.
The reason markets went on a tear from 2009 until early this year was all the stimulus that the Fed and Congress pumped into the economy. Stocks took off immediately, while it took longer for the economy to recover.
The same thing is happening today.
In fact, the stimulus this time around is much, much bigger than it was back in 2008.
According to McKinsey, global governments pumped $10 trillion into the economy in just the first two months of the Covid-19 Crisis.
That’s three times as much stimulus as the world created over the entire Great Financial Crisis!
Here in the U.S., the picture is similar. According to the Committee for a Responsible Federal Budget, the total amount of stimulus, measured as a percentage of GDP, this time around may well end up being similar to the 2008- 2014 stimulus.
But as this chart shows, the stimulus in 2020 hit almost completely all at once:
And keep in mind, the actual economic devastation back in 2009 was much worse than it’s been this year.
Yes, GDP absolutely cratered over the summer. But that wasn’t because banks were failing under bad loans, the housing market was crashing, and bubbles were popping.
No, this year it was because we decided to pause things to save lives from the Covid-19 pandemic.
Even before the pandemic is over, most of the very same economic activity has started to resume.
Unemployment has already recovered much faster this year than it did after 2008, as you can see in this chart:
GDP also took a bigger hit this year, but then recovered way quicker than in 2008:
In short, the 2020 pandemic has been an economic disaster, but a smaller one than the 2008 Financial Crisis.
So forget about all these concerns about why this bull market can’t last. And don’t miss out on another rally like the one we saw starting in 2009.
To get started, buy these stocks…
Stocks That Will Keep the Good Times Rolling
The two main sectors to invest in for this next rally are ones we’ve mentioned before.
First, we have infrastructure plays such as Martin Marietta Materials Inc. (MLM), and my favorite United Rentals Inc. (URI).
These are very different companies, but what they have in common is that they will both benefit as the economy continues to recover. And more importantly, one of the things that both the Democrats and Republicans can agree on is that more infrastructure spending is needed in the U.S.
That’s going to require more construction to use Martin Marietta’s aggregates and building materials. In addition, MLM is an extremely well-run company. Its recent Q3 earnings report highlighted an 18.9% year over year increase of earnings per share (EPS), mostly due to management’s successful navigation of the Covid-19 crisis.
Here’s the chart that shows today’s post-election profit-taking pullback to the 50-day moving average, I nice entry point for the stock:
Likewise, there will be more tool, and heavy equipment need for United Rentals to hire out to others. And URI is one of the best in the business, particularly for investors. United Rentals’ return on equity (ROE) – a measure of how efficiently a company turns investment capital into profits – of 22% more than doubles the industry average of 10%.
The chart looks similar with a pullback to nice support level for a preferred entry price:
Both of these infrastructure plays sprang up in the days leading up to the election because of the polls showing a blue sweep. Today’s big pullback is an overreaction that should give a preferred entry for stocks that have a strong chance for follow through in the coming months.
Second, we have Big Tech, which continues to show double-digit year-on-year revenue growth, regardless of the pandemic.
I especially like Microsoft Corp. (MSFT) because as we’ve talked about before, it has less antitrust headwinds compared to its competitors. And back to that double digit growth…
I know some small business owners locally that would love to have double-digit revenue, and that from a relatively small income base. It’s astonishing that the largest companies in the world continue to rack up double-digit growth but that’s why that continue to attract investors capital (and are worthy of attracting some more of yours).
MSFT grew revenue a whopping 12.4% Year-over-Year (YoY). And the growth was in areas that investors love to see. They Azure cloud business was up 48% YoY. Office 356 commercial gained 21% YoY and Xbox content services was up 30%. Plus, with the new XBOX release data is coming up on November 10th, this number is likely to really pop next quarter.
I also like Google’s parent company Alphabet Inc. (GOOGL), because despite the federal government’s antitrust lawsuit against it, the situation actually looks less onerous that most people anticipated.
As laid out in a recent 500-page document from the Department of Justice, which launched the lawsuit against Google, the claims against Google don’t look as problematic as they did at first.
And with the senate now looking like it will remain in the control of the red team, a destructive and sweeping antitrust action against AAPL, AMZN, FB and GOOGL looks less likely.
GOOGL also enjoyed a stellar earnings report with a YoY revenue jump of 10% and huge 32% from a year ago. Also, Google CEO Sundar Pichai announced that the company would break out their Google Cloud business as a separate reporting segment – news that analysts (and investors) will love since it gives more detail about this key growth segment for the company.
Combine all of these things with a deadlocked congress that’s unlikely to repeal the corporate tax cuts, and the both MSFT and GOOGL should continue to thrive.
Great trading, stay safe out there, and God bless you,
D.R. Barton, Jr.