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March Market Madness

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During this time last year, the NCAA canceled March Madness. With college basketball off the table, we were given a different type of madness: Market Madness. The S&P 500 drew down a total of 34% from peak to trough as COVID-19 wreaked havoc across global markets. This week marked the one year anniversary of that drawdown’s market bottom.

In September 2020, we wrote about the astounding fiscal and monetary policy action delivered by both the Federal Reserve and congressional lawmakers in response to the coronavirus. Although we complimented both the central bank and congress, the 2020 Most Valuable Player award quite honestly belongs to Jerome Powell and the Fed.

Today, after fending off last March’s Market Madness, the ball is no longer in the Fed’s court. Instead, The Fed is embodying a more reactive approach, awaiting signs of inflation to cross their 2% target before considering rate hikes or tools such as yield-curve control. Now, it’s our congressional leaders’ turn to play offense using fiscal policy. Their most recent time-out play is the $1.9 trillion stimulus package with embedded $1,400 stimulus payments expected to boost inflation.

Is Inflation Bad?

Let’s take a step back and consider why the Fed is setting a target with inflation. It’s important to distinguish that inflation isn’t as daunting as what’s ingrained in our history books. Sure, the inflationary tales of Zimbabwe and the Weimar Republic might seem scary, but the truth is such situations are rare and due to mismanaged policy in less-developed nations. Typically, mild inflation is a sign of rising consumption and increased demand. Today, this type of inflation can be recognized as reflation1; and in our case, reflation would signify that a return to normalcy is en route. 

Market expectations for inflation are no laughing matter. A re-opening is expected to usher in increased spending in the form of pent-up demand. Input prices such as lumber and copper are already soaring. The five year breakeven treasury rate, which measures investor expectations for inflation, rose to its highest over point ever since 2014. Bonds, whose kryptonite is inflation, witnessed a sell-off that trickled into tech stocks.

But are markets correct to expect this much inflation? Or are markets overshooting their expectations by falling for this inflation pump fake? Perhaps our stay-at-home habits will prevail in the long-run and spending will not stay elevated, resulting in lower inflationary pressures. If so, we could see a rebound in bond prices and tech names. Nevertheless, this is the hotly debated topic among investors at the moment. 

Run The Play

This brings us back to the analogy with our administration’s most recent time-out-play. The $1.9 trillion relief bill is bringing hope to the workers, businesses, institutions, and communities that have struggled throughout this pandemic. As you can see in the chart below, the $1,400 stimulus payments represent a large percent of the package totalling $422 billion. It makes sense for investors to expect increased inflation as consumers now have higher disposable incomes and propensity to consume – but there is a catch.

Source: Committee For a Responsible Federal Budget (CRFB)

What will happen to actual inflation if these stimulus payments don’t make it back into the economy, but instead find their way into the stock market? A survey by Deutsche Bank revealed that individuals between the ages of 25 to 34 intend on placing 50% of the received payment into the stock market. Ultimately, the survey found that younger and high income earners eyed the stock market as the targeted destination for this income.

Source: Deutsche Bank Asset Allocation, dgDIG, RealVisionFinance
Data presented on 3/08/2021

The Deutsche Bank survey, like any other, is going to be scrutinized for sampling error, but we don’t see something like the above being too far-fetched. The recent retail frenzy with “meme stocks2” like GameStop, Blackberry, and AMC has given rise to retail investing. Popular communities like r/WallStreetBets on Reddit have become a breeding ground for investors to commingle. Even more likely are your neighbors, who watched people get rich on the market’s 2020 rally, itching to pummel some of their stimulus money into the S&P 500.

These $1,400 payments are intended to increase demand for goods and prompt businesses to hire more workers, eventually raising wages. If these payments seek risk-assets instead, we could see a halt in the reflation narrative and a prolonged unemployment recovery.

Another risk to consider is the risk of financial stability. We’re seeing speculative behavior, especially from retail investors piling into stocks with less regard for the underlying fundamentals. At the end of the day, it’s quite possible to see a lack of wage growth in the economy while management teams of inefficient and highly-indebted companies get rewarded for little to no profitability.

The Bottom Line

We aren’t here to debate whether or not you should save or spend the money, let’s leave that to Reddit and Twitter. However, should a substantial portion of stimulus payments see capital markets as a more attractive destination than the underlying economy, the risks to reflation and financial stability must not be overlooked.     

We’ll see whether or not the $1.9 trillion time-out play will win the economic recovery game and prevent further Market Madness… if not, let’s hope it at least takes us into overtime.

Footnotes:

  1. Reflation represents increased price levels as a result of monetary or fiscal policy as a means to combat deflation.  
  2. “Meme stocks” are stocks that have gained traction from retail audiences such as Reddit or investment communities. GameStop and AMC are just a few of the many names with this retail comradery, earning these stocks the nickname “meme stocks” and causing a surge in prices throughout early 2021.

Sources: 

Committee For a Responsible Congressional Budget 

Deustche Bank Survey

YCharts

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

How Will Emerging Markets “Emerge” From 2020?

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It’s no doubt that U.S. equities remain the protagonist of the past decade. The longest U.S. economic expansion, coupled with the blossoming of numerous tech stocks like Amazon and Tesla, helped the S&P 500 climb to record highs. That was soon followed by the U.S. stock market’s astounding recovery in 2020, which continues to capture the attention of global investors.

Many forget, however, that the decade before looked entirely different. Back then, we had an entirely different “darling” called emerging markets which left the S&P 500 in the dust.

Data spanning 12-31-1999 to 12-31-2009

During the 2000’s, emerging market investments drastically outperformed the S&P 500 by 188.1% on a total return basis. Steadying economic data and optimistic outlooks for EM nations including Brazil, Russia, India, and China, or the BRIC nations, painted narratives of a new global convergence. Meanwhile, U.S. stocks continued limping from the aftermath of the dotcom bubble.

The Case for Emerging Markets

EM investments invest in the securities of a less developed country with improving economic conditions and increased involvement with the global economy. Aside from the BRIC nations, this includes countries such as Vietnam, Indonesia, Africa, and Argentina. EM regions are attractive for the following reasons:

  • Growing Contribution to GDP: Over the past few years, emerging economies contributed an increasingly higher percent share to global productivity. EM contribution to GDP was 56.9% in 2019, while advanced economies contributed 43.1%. The International Monetary Fund (IMF) forecasts this trend to continue into 2024, making emerging markets an attractive long-term investment opportunity.
Data as of 6-30-2020. Source: IMF
  • Favorable Demographics: 85% of the world’s population, or about 6 billion people, reside within emerging countries. Over 50% of the global population under the age of 30 live in EM nations. This will fuel a rising-middle class in years to come. Increased productivity amongst large-working populations will also uplift the region’s standard of living.
  • Hot Spot for Disruptive Innovation: Emerging markets typically lack the infrastructure and technologies of developed nations. This presents ample opportunity for the region’s younger, more tech-savvy population to embrace innovation. Global leaders including the World Bank have also recognized the tech disparity and have provided funding for infrastructure enhancements.

COVID-19 in Emerging Markets – Some Juggle While Others Struggle

Contrary to expectations, emerging markets have weathered the pandemic better than expected. A younger population and lower obesity rates have helped certain emerging countries wither down mortality rates. Accommodative fiscal and monetary policy through asset purchases and fiscal stimulus modeled after developed nations helped keep many economies afloat.

East Asian countries, China in particular, have exemplified great handling of the Coronavirus. As a result, EM has rallied 24.3% since the market bottomed (data spanning March 23 to December 8). China is also the only country expected to report positive GDP growth for 2020. Although it’s best to view Chinese data with a skeptical eye, investors cannot deny the nation’s swift return to economic activity.

Data as of 12-08-2020

Nevertheless, China’s success isn’t shared by all. Developing nations dependent on oil exports, tourism, or general commodities have and will continue to struggle as trade activity remains low. Certain EM hotspots including Russia and Brazil are also finding difficulty with containing virus spread. Highly indebted economies face risks of debt sustainability with limited room for policy enactment.

The Emerging Markets Story…to be Valued

EM equities experienced a mass exodus in March as investors questioned whether the infrastructure and economic inexperience of developing countries could properly combat the Coronavirus. Fund flows faced pressures until investors began acknowledging fruitful economic and health responses to COVID-19. Even after rallying this year, the long-term valuations for emerging markets look attractive.

Data as of 9-30-2020. Source: StarCapital

According to StarCapital research, emerging markets have the cheapest cyclically adjusted price to earnings ratio (CAPE) and price-to-book (P/B) ratio relative to developed countries over the next 10-15 years. Factor in the expected structural improvements, emerging markets exhibit ample opportunity for value appreciation should the demographic and technological trends fall in line. You may also find comfort in knowing that emerging markets are expected to have the sharpest recovery post COVID-19.

Data as of 10-16-2020. Source: Wall Street Journal

What Will the Next Decade Look Like?

Despite some commendable pandemic responses and attractive valuations over the next decade, it is imperative to consider COVID-19’s impact on the region’s secular trends. Take China’s “Great Rebalancing,” for example. After years of export-driven GDP growth, the country adopted a “Great Rebalancing” plan to generate their economic prowess from organic consumer-driven activity rather than overseas trade.

When the Coronavirus struck, both Chinese businesses and consumers halted activity. Unwilling consumers, shocked by the events in Wuhan, emptied the streets as factories shut down. Once a recovery was en-route, business activity quickly climbed back to pre-pandemic levels, but scarred consumers left their homes thrift-conscious and hesitant. This led some to believe that China’s “Great Rebalancing” plan was at stake.

The Chinese customer today, has regained confidence, mainly from the government’s ability to eliminate almost any possibility of second wave. As we said earlier, China’s success is not shared by all, and whether or not secular trends will hold in other emerging nations — who have varying health and economic conditions – will be a mixed bag.

Bringing It All Home

Although prudent investors can exploit opportunities in countries that have exhibited short-term resiliency, the ability to maintain a long-term perspective and understand the landscape of your investments is keen. Here at Warren Street Wealth Advisers, our focus is not only to avoid home-country bias and to uncover the next areas of outperformance, but also to educate our clients about our long-term decision making.

For any questions regarding international investments, emerging markets, or wealth management, please call 714-876-6200 or email phillip@warrenstreetwealth.com. 

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.