What Am I Learning?
By Raz Pounardjian | May 7, 2020 | View This Email In Your Browser
Despite everything happening in the world, April was the best month for the stock market since 1987. I have been thinking a lot recently about what lessons I am learning during this time.
Markets anticipate bad economic data
The stock market is not the economy and vice versa. One of the most difficult parts of investing is understanding market expectations. From February 19 th to March 23 rd , the S&P 500 fell -34%, international stocks -33% and small cap stocks -41%. Stocks were falling in anticipation of the bad economic data that would follow. When the bad economic data started to come in, markets rallied. Why? Because although the news was bad, it was not as bad as expected. The stock market is a discounting mechanism that was already looking ahead. The below chart illustrates this point:
The stock market was going up at the end of March, even as initial jobless claims were coming in at record levels. The market leading up to that point fell so sharply and quickly, that it likely accounted for this bad data. Michael Batnick recently said: “Nobody wants to read a headline “Stocks rise as things are terrible but not catastrophic,” but this is usually closer to the truth than any other explanation.”
The S&P 500 only tells a part of the story
A diversified portfolio usually includes large cap, small cap and international stocks. Year-to-Date, the S&P 500 Index is down about -11% because it is weighted by the largest companies. Six of the top ten holdings in the index are tech based and they make up 21% of the total index. These companies (Microsoft, Amazon, Google) have experienced a muted impact by the economic slowdown. The Russell 2000, an index of smaller companies and less concentrated than the S&P 500, is down -24% YTD. Small cap stocks have more exposure to sectors such as financials, industrials and real estate, which are sectors more negatively impacted by the economic shutdown. Even international equities are down -20% YTD. While the headline return of the S&P 500 does not look as bad, beneath the surface, a diversified portfolio has likely fared worse.
Do not fight the Fed (or the Treasury and Congress)
I give Fed Chairman Jerome Powell and members of Congress and Treasury credit for acting as quickly as they did during this crisis. Congress came together to pass the CARES Act to help small businesses and the unemployed. Powell told Speaker of the House Nancy Pelosi that since interest rates would stay at all-time lows, that she should “think big fiscally” when it came to creating the CARES Act.
In the last two months, the Fed has lowered interest rates to nearly zero, announced an unlimited quantitative easing bond buying program and $2.3T in financing for businesses and municipalities. Powell is launching the equivalent of a B-52 to combat this recession. I think one reason for the sharp recovery in the stock market is due to the actions taken by the Fed and Congress to do whatever it takes to help individuals, businesses and municipalities.
Incentives still drive behavior
One of the programs within the CARES Act was the Paycheck Protection Program or PPP. This program is intended to give small businesses loans (mostly to ease payroll challenges) via the Small Business Administration. The thinking is that if the government lends money to these businesses for the main purpose of keeping employees, that the damage to the economy will be less severe.
When the government is handing out the equivalent of free money; public corporations and universities with billion-dollar endowments were at the front of the line and received funds from this program. Even with a combined $93B in endowment assets, Harvard, Stanford and Princeton all applied and received PPP funds (that were later returned). The Los Angeles Lakers received $4.6M in PPP funds (that too were returned), despite the franchise being valued at $4.6B.

Over 40 public companies received loans between $3-$15M. Public companies have access to capital markets to sell debt and equity. Isn’t this one of the main reasons corporations go public? Your locally owned hardware store cannot sell shares to the public and does not have the same access to capital markets. Aren’t small businesses the lifeblood of our economy?

This hurts the economy because smaller businesses are being crowded out and must wait longer to get help, potentially forcing them to lay off employees. It increases the deficit because those who do not need PPP are taking it and the program must be funded further. The saying goes: “Show me the incentives and I will show you the outcome.”

I think I will get off my soapbox now. 

Raz Pounardjian
Portfolio Manager
30300 Chagrin Blvd., Pepper Pike, OH 44124
Direct: 216.706.2811 Cell: 216.272.4320 Fax: 216.523.8380 Toll-free: 800.321.2322

Carnegie Investment Counsel is a registered investment adviser with the Securities and Exchange Commission (SEC). The opinions presented are subject to change without notice. Performance information was obtained from third party sources. Although these sources are widely used, and Carnegie deems these sources reliable, Carnegie makes no guarantee as to the accuracy of the information provided by these third parties. The information provided is for general informational purposes only and should not be considered a solicitation to effect transactions in securities or personalized investment advice. Past performance is not a guarantee of future performance.
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