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COVID update and August Markets Update

COVID update and August Markets Update

September 02, 2020
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Updates from the Front Line in the War Against COVID

Since most news provides only the sketchiest of headlines and few details, I thought I would share this very detailed and thoughtful report from the good people at Morningstar.  It details the latest developments with treatment, and trends in the spread and efforts at containment.  Excellent article. 

https://www.morningstar.com/articles/1000385/slow-burn-likely-until-coronavirus-vaccines-are-widely-available

A Strong August for Investors

Meanwhile, August was a very strong month for stocks and investment portfolios generally.  Looking back now over the trailing 12 month period, most investors will see returns in line with long run averages.  It is almost as if nothing has happened over the past 12 months!  (As a reminder, Financial Pathways investors can always view their recent investment results online at https://investorview.assetbook.com).

How so, with the pandemic clearly stifling the economy?  Many investors seem to have a "too good to be true" feeling about investment markets.  And it does seem somewhat surreal to have stocks at new highs while we live in this era of uncertainty.

But the investment markets are much more complex than just a short term economic outlook.  There are many factors at work supporting markets, even during the current downturn.  Here's a rundown of key reasons the market is doing well despite the overall gloom:

Not all stocks are equal.  Obviously, companies like Zoom, Amazon, and Google thrive in a "stay at home" environment.  Less obvious are firms like Home Depot, and by extension, building supply makers who benefit from the surge of remodeling, deck building, etc.  The truth is that some companies have been hurt severely such as travel and hospitality (and their stocks reflect the pain!), others are muddling through (financial firms), and some companies are thriving.  In our new economy, the tech companies (largely thriving) represent a much larger share of the whole than the "old economy" stocks that are struggling.  This is one reason the market averages are doing so well.  Moving forward, as we move beyond pandemic, the opportunities for further growth are likely more with the "old economy" value stocks.  

Cash is King.  Despite the pandemic and rising unemployment, personal incomes rose substantially this year. This was a result of the many stimulus programs, enhanced unemployment, etc.  More money in people's pockets and less opportunity to spend means more money gets invested, driving the price of stocks higher.  This effect may wane as stimulus becomes less generous moving forward. 

0% Interest.  Not many people want to earn 0.5% in return for tying up money for 10 years.  With save investments like CDs and Treasury bonds yielding not much more than 0%, the price of stocks is bound to increase.  This is a basic tenet of stock valuation.  The lower the "risk free interest rate" the more people will pay for each dollar of profit a company generates for its stockholders. 

Stock prices reflect ALL future earnings, not just this year.  When the stock market values a company, it doesn't consider what will only happen this year.  Instead it uses all future projected earnings.  And the lower interest rates are, the more valuable those far in the future earnings may be worth (particularly for growth companies).  So the market is not ignorant of the current recession - it is just that reducing expectations for only the next 12-18 months doesn't really reduce the stock price all that much. 

But there are some signs of excess!  Perhaps driven by a rise in popularity of "day trading" some favored "story stocks" are being driven to outrageous levels reminiscent of the 90s internet boom.  Tesla, Zoom, and many of the firms working on COVID treatments and vaccines are among the most popular stocks with these mostly young and inexperienced traders.  To some extent, almost all of big tech seems overpriced.  But by owning the whole market using passive investing approaches that we favor, and particular with the profitability and value screens that Dimensional uses in its strategies, the impacts of this type of speculation (and the carnage that inevitably follows) on an investors portfolio is likely to be contained, while the opportunity to benefit from recovery in "the rest of the economy" is maintained.