Very few are factoring in the COVID-19 consequences on the ongoing rally in the stock markets. What’s making headlines is the fact that Standard and Poor’s 500 has hit an all-time high wiping out all the losses since the pandemic started. This looks like the greatest recovery ever as the markets have rallied more in the past three months than any time in history.
Is it not strange to see greed overtaking fear amid the mother of all challenges? What is widely known as the FOMO factor (Fear OF Missing Out) can be explained with the fact that markets are rising defying the raging virus, investors are taking on exceedingly more risk even when they know that this can have serious repercussions.
Why are the Bulls winning?
The bulls argue that this party can last longer as the Central banks are willing to expand their balance sheets in order to cushion the effect of the pandemic on economies. Moreover, as long as the interest rates stay in the negative range, savers are forced to invest their surplus in the riskier assets such as equity. This is evident as the yield on the 10-year inflation-linked US government bond sank below minus 1 percent (to a historic low). Subzero yields have existed in countries like Japan, the Eurozone and the UK as well. India too has a real interest rate of -1.87 percent (repo rate of 4% and retail CPI inflation of 5.87%).
Notwithstanding the varied fiscal commitments of governments- from generous support in most of the developed Western countries to paltry commitment in countries such as India- equities are brushing aside the economic fall out of the pandemic.
The rally going into risky pockets.
The investors know that there is a rising risk of loss but they are willfully ignoring the facts and piling onto more risk because the narrative has simply become “fundamentals don’t matter.” The S&P 500 made new all-time highs just because 6% of the stocks touched their 52-week highs.
Fun fact: The combined market capitalization of FANGMAN i.e. Facebook, Apple, Netflix, Google, Microsoft, Amazon and Nvidia has hit a fresh record of $7.6 trillion which is almost equal to the combined GDP of India and Japan.
While we agree on the weakness of the US dollar on the back of the burgeoning US deficit is positive for emerging market equities, and central bank liquidity and negative rates are other enablers, investors are expected to pay due cognizance to earnings as well. Somewhere down the line, the ability for stocks to grow earnings at a rate to support high valuations will become problematic.
What markets may be ignoring are two significant risks i.e. rising debts are deficits that could impair economic growth in developed markets. In India, the problem gets even worse due to the lack of a fiscal muscle by the government which makes the revival task more arduous.
All of this doesn't mean that stocks cannot go higher in the near term, and despite the above-mentioned facts, the rally may continue simply because of the bullish bias or the momentum.
Having said that, investors are staring at a possibility of single-digit upside and a probable larger downside, if the bullish sentiment doesn't t into ground reality.
As Howard Marks, the famous investor says, “You can’t predict. You can prepare”.
Having seen windfall gains in the past few months, it is not a bad idea to increase the cash quotient in your portfolios while still staying invested in high conviction ideas.
Disclaimer: Views are confined to my horizon of understanding.
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