2020 What " Should " Have Happened
A conversation I’ve had in several recent appointments when discussing the events of 2020 goes like this. “It shouldn’t have happened.” Of course what “should” happen is a useless concept, but here is the sentiment. No, its not the pandemic that shouldn’t have happened. Although infrequent, widespread disease is a natural event like an earthquake, flood or hurricane and has been knocking on our door for some time with Swine Flu, SARs, MERs etc. I’m talking about the stock market reaction. When significant events like this happen, confine most to our homes for months at a time and disrupt the business cycle, people who own assets are supposed to get hurt - at least temporarily. That is the nature of the game.
What is helpful to understand here is a company’s value, really anything’s investment value, is the future cash flows it will create discounted back to the present to adjust for the time it takes to make that cash and the risk (or relative certainty of making them) taken.
So, in March of 2020 with the onset of the pandemic, stocks had their typical reaction in the face of uncertainty. They sold off. However while uncertainty remained, the market as measured by the S&P 500 regained most of what was lost by June and ended the year significantly higher as most of you know by now.
As I said in my previous letter, attempting to explain the happenings of the economy and stock market is nearly as significant a folly as trying to predict them, but I can’t help but wonder, “why did this happen?”
I think we got as good of a look as were ever going to get at the “why” via events that took place as 2020 wound down. Not only was the pandemic risk still present through the end of the year, but we had a major election that was long anticipated to be one of the most contentious in history and it did not disappoint.
The first event late in 2020 was the election itself. Could we facilitate an effective election while many, especially the primary voting public, felt it a risk to leave their homes? It turns out the answer was yes, but it brought the second concern into full view.
Going back to the middle of his presidency, many were concerned that if the sitting President lost re-election; he would not acknowledge the results. This of course transpired, but when we not only failed to name a clear winner of the election days after it had taken place as was feared, but lawsuits started being filed to challenge the election, the markets shrugged it off and went higher. Remember, the thing that markets hate most is uncertainty. What could be more uncertain than not knowing who was going to lead the country? So, this was perplexing to say the least.
As January approached with more clarity, but remaining uncertainty that culminated with the sitting president inciting an insurrection at the US Capitol seemingly threatening the American democracy itself, I turned on CNBC the following morning expecting the worst, but to my great surprise, the stock market went up. Huh?
Then it all became clear. The one thing that remained constant as all of these feared risks came to pass and failed to have their typical impact was the Governments intervention in markets. The Fed’s reduction in interest rates and the treasury printing money and giving it away to American’s, many who frankly didn’t need it, kept the market rallying right through the end of 2020 and roaring into 2021.
Is this a good thing? I’m not so sure. It probably sounds strange for a “financial guy” to be lamenting the increase in the stock market, but here are my thoughts.
There are unintended consequences of intervening in any situation.
A popular concern among many including the politicians seems to be that of a wealth gap among Americans and its recent exponential growth. The phenomenon of compounding explains much of why those who have accumulated capital’s wealth has accelerated, but I can’t help but notice this has happened in conjunction with the increasing Government intervention to prop up asset prices (including the Federal Reserve directly purchasing assets during the latest crisis). Previously down economic periods provided opportunities for those who had fallen behind to catch up. However now the Government is so afraid of a down economy, they have basically intervened to remove this opportunity while simultaneously lamenting its unintended consequence.
One of the main tools of intervention is the manipulation of interest rates. Being most of our economy runs on credit, a reduction in rate provides an increase in buying power for those willing to sell their future time to have the things they want right now. This provides a shot in the arm to the economy, but with an increased supply of buyers, prices go up. What is the concern? Well, for retirees who can’t afford to put capital at risk and need a return on safe assets to fund their lifestyles, this is a problem. Increasing demand driving up prices makes that problem worse.
There is a risk in investing in companies compared to putting your money in the bank. Built into the capitalist system there must be the risk of failure. Seeing the market perpetually go up with little to non-existent returns on safe assets may result in people taking more risk than their personal situation can afford only to injure themselves in the future when the market does what it is supposed to do.
Most of the clients that I work with are high earning young people who are in the accumulation phase of the financial lifecycle. Were buying heavily. It’s great when markets go up, don’t get me wrong, but you don’t go to the store when you need something and hope that it has gone up in price since the last time you went shopping. The Government propping up asset prices has robbed accumulators of “buying on sale” outside of that short period between March and June.
These concerns are as they say the tip of the iceberg.
Following this conversation, a popular question from clients is what do I think will happen this year. I’m not much for prognostication, but I will tell you what I see. People have been locked up in their homes for the better part of a year. Most of them have been earning the same or in some cases more money than they were prior to the pandemic with little to no opportunity to spend it. Savings rates are at an all-time high.
Low interest rates have allowed us to refinance just about every client’s mortgage reducing cash outflows that would have otherwise gone to housing. Many, even those who didn’t need it, have been given stimulus money by the Government on top of that savings.
We are a consumption culture at our core. Clients and others I talk to are completely fed up with this lifestyle and are ready for life to resume to normal and have big plans when it does. Travel is going to be huge. It is always a priority with the folks I work with, but in basically all of the conversations I’ve had over the past month, it is the top priority for discretionary funds.
We’ve already purchased one vehicle this year and the ever present “third row SUV” has moved up in the goal timeline as people are eager to get back out on the road for that family road trip or make the commute to the office more comfortable when that happens again.
Basically, the economy, particularly the experience economy (travel, restaurants etc) looks like a coiled spring with significant cash savings and very low interest rates to fuel it. With a third round of stimulus on tap from the new administration adding to the cash that will be injected into the economy, and the best stimulus of all, the vaccine, becoming more widely distributed I expect we will see Americans do what they do best and consume at an unprecedented pace to make up for lost time.
Active Lifestyle Financial Planning