By Justin Carbonneau (@jjcarbonneau)
They say a picture is worth a thousand words. The pictures and charts outlined below may actually be worth much more:
- 30 million unemployed.
- $7 trillion on the Fed’s balance sheet.
- Just how much the Amazons, Googles and Large Cap technology stocks have delivered over other areas of the market like value.
- A 250% increase and a 50% decrease in Internet search trends and behavioral shifts.
- 40 years of falling interest rates.
- An indicator showing a massive amount of liquidity potentially coming down the pike.
- Surge in people seeking news, information and advice in uncertain times.
In isolation, each of these statistics is staggering and unprecedented, and most will have significant implications for the markets, economy, consumption and behaviors for years to come. While it’s impossible to know what the future holds, it’s important to consider how these factors could impact your portfolio, both in the near and longer term.
When you hear about the millions of people who have lost their jobs, it’s difficult to put it in context. When you see it illustrated in a chart, it’s easier to process.
Initial claims exploded from more than 200,000 to millions within a week. From March 21st through April 30th, over 30 million people have filed for unemployment. To put it in perspective, consider that 30 million people represents the population of our second largest state (California is the largest with 37 million and Texas is second largest with 29 million). No other period in our history besides the 1960s comes close to that level of unemployment. I’ve superimposed a red line on the right-hand-side of the chart above to illustrate this rocket-like spike in claims.
How quickly people get back to work, as well as the level of damage caused by subsequent lower spending, will be significant determinants of the type of recovery we may be facing (V, U, L, or W).
The Fed’s Balance Sheet
The U.S. Government’s response to the COVID economic crisis has been swift, and the Federal Reserve has had massive influence in credit and equity markets by lowering interest rates and implementing a number of facilities and actions to ensure that markets function and maintain liquidity.
Unless you’re an economist or banker, understanding each of the facilities can be bit tricky, but you don’t need to be an expert to see how much the Fed has injected into the system. The chart below shows the Fed’s balance sheet.
Notice the big jump in 2008—during the Great Financial Crisis – when the balance sheet jumped from roughly $1 trillion to $2.2 trillion. From late 2010 through mid-2014, another $2 trillion was added — this was a period of continued Quantitative Easing, where the Fed was buying U.S. issued debt and mortgage-backed securities. On the right-hand side of the chart, you’ll see another big uptick representing the increase over the last month or so from around $4 trillion to nearly $7 trillion.
The 600% increase in assets on the Fed’s balance sheet over the past 12 years has many implications. One interesting question was posed by Ben Carlson, popular financial blogger and Director of Institutional Asset Management at Ritholtz Wealth Management: If the Fed can come into the market and take the dramatic steps it has recently to limit the chances for a depression-like hit to the economy, does that mean the future returns of stocks should be lower because the risk of a massive wipeout of stocks (i.e. a 75% decline) is off the table?
Large Cap Tech Above Everything Else
In 2008, there was a massive reset in stocks and a deep recession in the wake of the financial crisis. In retrospect, it’s clear that this also marked a huge shift in the types of stocks that would outperform over the ensuing decade.
Over the last 12 years, growth stocks have beaten value and large caps have beaten small caps. To a large extent, this is the opposite of what has worked over the very long term; i.e. value stocks tend to outperform growth and small caps, particularly quality names, tend to outperform large caps.
The above chart shows the actual performance of three ETFs – the Russell 2000 Value ETF (IWN), the Russell 1000 Growth ETF (IWF) and the Nasdaq 100 ETF (QQQ) – from 12/31/2008 to 4/28/2020. The 353% return of the Russell 1000 Growth ETF demolished that of the Russell 2000 Value ETF, which is up only 86%. But the big winner is the Nasdaq 100 – up 611%, or over 7x the return of the leading small cap value index.
One thing we know for certain is that, over time, different market regimes reward different types of stocks and stock market leadership changes. The spread in valuations between the smallest, cheapest stocks in the market and the largest, growth-like stocks in the market is now at historic levels, as Jamie Catherwood and Travis Fairchild of O’Shaughnessy Asset Management recently wrote. Investing isn’t an all or nothing game, but those investors who make bets on one stock category or another could end up being either much better or much worse off, depending on whether these trends continue.
Internet Search Trends and Behavioral Shifts
The impact of COVID-19 and the related shutdown has been vast, both on our daily lives and on our behaviors. The chart below, a modified version taken from Cloudflare (see full chart here), shows the increase and decrease in Internet consumer search categories . As you might suspect, online learning and resources for kids have seen a huge uptick, while things like professional sports categories are down by some 50%.
America will eventually get back to work, kids will go back to school and we’ll have basketball and football games again, but thinking through the longer-range implications of what people are consuming online should be considered as investors ponder what the future may hold.
40 Years of Falling Interest Rates
The chart below, taken from a Federal Reserve article, shows interest rates dating back to 1880 along with the Cyclically Adjusted Price-Earnings Ratio (CAPE) of the stock market.
Starting around 1940, long-term rates started to gradually rise, and for the next forty years they went higher, peaking in the early 80s at about 15%. Over the last forty years, we’ve seen rates steadily decline to below 1%.
There are a few implications for investors to consider:
- The lower the rates on long term bonds, the less they can compete with stocks. Of course, stocks are much riskier in the short run but investors with a 10+ year times horizon are far more likely to see growth in purchasing power by buying stocks versus. bonds.
- A low interest rate environment presents an attractive time to borrow. Not only can the U.S. finance deficits and stimulus programs at low rates, but the low interest expense flows down to companies and individuals as well.
- One can’t help but think that the 40-year bull market in bonds, which started in 1981, is nearing its end and that we’ll look back on this chart years from now and say we can’t believe rates got so low.
In a recent advisor-only conference call hosted by WisdomTree Investments, professor, macroeconomist, author and market historian, Jeremy Seigel pointed out something he has never seen in his entire career — the explosive growth of the M1 Money Supply, which measures the amount of money in circulation and the amount in bank checking accounts. This is a true measure of liquidity since the funds are available to be spent on goods and services.
Seigel’s overarching point was that M1 has spiked of late due to unemployment and stimulus as well as from a reduction in spending on goods and services, and should eventually find its way back into the economy. Higher inflation down the road could be one of the potential consequences of this liquidity.
Surge in People Seeking Information
During uncertain times, humans tend to look for answers. Our survival instincts kick in and we seek out information and opinions from others whose knowledge and views are primarily aligned with ours and, therefore, best support our desired outcome.
In the table below, you’ll clearly see how this plays out in terms of traffic patterns to major news and business web sites:
|News Site||Dec-19||20-Mar||% Increase|
|New York Times||243,000,000||569,000,000||134%|
Investors and individuals flocked to these sources, resulting in huge increases in traffic. For example, The Wall Street Journal had about 47 million site visits in Dec. 2019. In March 2020, the number of visits more than doubled to nearly 95 million.
I give a lot of credit to the news organizations who stayed operational and pivoted to remote hosting and production. But it’s important for investors to understand that these same news organizations want you tuning in and coming back more and more often. They do this by playing off emotions like fear and greed to drive viewership and audience acquisition—an important perspective to keep in mind. Most investors should avoid relying on news headlines when forming a long-term investing strategy.
Key Takeaway – Temper Emotions, Think Long-Term
It’s tough to know how to process the disruption that the above charts illustrate other than to brace ourselves for what comes next, a concept underscored this past weekend, when Warren Buffett and Charlie Munger conducted Berkshire’s Hathaway’s first-ever virtual annual meeting. The investing power team answered questions and offered truthful, evergreen feedback on investing, the state of the economy and the wide range of potential outcomes as a result of the coronavirus pandemic.
At one point, Buffett said: “I don’t believe anyone knows what the market is going to do tomorrow, next week, next month, next year.”
Trying to predict the future in normal times is very difficult, but add the shock of the pandemic and resulting economic shutdown and it’s virtually impossible to get a sense of the true impact of recent events. The charts I’ve shared offer some semblance of just how massive this event is and highlight the importance for investors of tempering emotions and managing their portfolios with a long-term perspective, balancing risk and return — just like Buffett. Those investors stand the greatest chance of emerging the least scathed as we navigate through this historic period of time.
Photo: Copyright: 123rf.com / alphaspirit