how the pandemic “bubble” might play out from here

“This time is different” is one of the scariest sentences any investor can utter. That’s chiefly because humans’ capacity for denying unpleasant truths is close to boundless. It’s also that this thought mostly comes up when a market is toppy and is typically a sign that a downdraft in stock prices is near.

In recent posts, I’ve written about the runups to the two big bear markets I’ve lived through that most remind me of where we are today: one was in Japan in 1989, when the Japanese government decided to end a period of wild, and increasingly damaging, speculation by raising interest rates; and the other was in the US in 2000, when demand for internet infrastructure devices and components came to a screeching halt and no Y2K computer glitches appeared. As is the case in any bear market I can think of, the trigger for each was an economic event that had important consequences for financial instruments. In Japan, rising rates; in the US, an unexpected slowdown in a key industrial area.

What’s peculiar (I didn’t say different, but it amounts to the same thing) about today’s situation is that a number of deeply adverse economic events have already occurred without the domestic stock market falling apart: several years of Trump’s growth-inhibiting economic program, the economic devastation caused by his “it’s a hoax” response to the external shock of the pandemic, his violence-laced effort at a coup to overthrow the newly elected government when voters decided to replace him, and the approval/support he continues to get from many leading lights in Congress. It’s like a super bad movie plot of racism and ineptitude–only it’s real.

Yes, the stock market declined by 30%+ last February-March. But it recovered just as quickly and ended 2020 comfortably in the black. That’s because the Fed dropped short-term borrowing rates from 1.5% to basically zero and Congress applied substantial fiscal stimulus. That combination has so far averted a deeper, longer economic and stock market downturn. More fiscal stimulus may also be on the way.

What happens from this point? My guess is that as vaccines gradually get distributed widely, the consumer economy starts to return toward normal. It seems to me there’s already some evidence of this happening in macroeconomic data, although I don’t yet see a strong reaction in the bricks-and-mortar retail part of the stock market.

Three key stock investment questions associated with potential recovery:

–how closely will the new normal resemble the old? This is about which current quarantine beneficiaries get left behind and what consumer names the market rotates into

–when does the economy become strong enough for rates to rise? Not soon, but rising rates implies PE compression

–from a longer-term, more conceptual point of view, there’s the Iraq war, the US-spawned financial crisis of 2007-09 and the damaging Trump administration. The three have conspired to give the US a considerable black eye in the rest of the world. That’s not only as a location for new plant and equipment but also as a place to visit, to research or be educated and as a country whose stocks and bonds one might want to own. One of the hallmarks of the Trump presidency has been the capital flight this has generated. Just look at the spread between NASDAQ and the Russell 2000 during 2018-20. An important long-term question, and only time will tell, is if and how this will reverse, i.e., whether the current surge in the R2000 is the beginning of a new trend or just a strong countertrend rally. Even with a pessimistic point of view, however, my thought is that relative strength of domestic-oriented names will continue throughout this year.

2 responses

    • I got a merch email from ARK yesterday. In the old-style brokerage business, these things are typically giveaways to motivate a salesforce or to reward large customers for their business. That’s not the case here. I think you’re right to worry that ARK might be starting to “live the legend,” which is an early sign of trouble. Of course–this is not my #1 explanation–ARK may be responding to requests from a fanbase that wants to celebrate a woman CEO in a notoriously equal opportunity laggard industry, who is trouncing the old guard with an innovative business model.

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