Broker Check

Does It Feel Like The Stock Market Is Sprinting?

| April 13, 2021
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Global equity markets have posted strong returns thus far in 2021 following what turned out to be a stellar finish to 2020. Diversified portfolios that are structured with a full equity market participation mandate have outpaced bonds by more than 10% for the year and by more than 17% since January 2020, as compared through the date of this commentary. Although no one is unhappy about the results, the prudent analysis would be to gauge whether the upside is justified from a fundamental standpoint. The importance of answering such a question can play a tremendous role in risk management decisions through the end of the year. Let us break it down.

For starters, it is critical to understand that the stock market and the economy are separate entities that should never be compared simultaneously. The stock market is more of a current and leading indicator while most economic data points that are released monthly are lagging indicators of something that has already happened in the past. Think of the labor market as an example. The monthly payrolls data is lagging in nature because it is telling us about something that already happened over the previous four weeks. If we were to learn that last month’s payrolls were stellar, the stock market may take such a figure and amplify stock returns in hopes that next month’s payroll figures are higher (which may mean more discretionary income for spending). The reality is that we will not know the labor market result until a month later, which may prove the market right, or wrong. That is the simplified explanation of how the equity market moves on a forward-looking anticipation basis. Such a relationship between stocks and the economy has proven to work well historically over longer market cycles while there are also plenty of examples of the market’s disconnect to the economy in the short-term. We define a longer market cycle as a minimum of five years while short-term refers to less than three years.

The dynamic between stocks and the economy deserves meticulous attention in today’s environment as a means of managing strategic, tactical, and long-term allocations. A strong argument can be made that global equity markets may have priced-in exuberant economic activity over the next 12-months. Various data points appear to indicate that fundamentals within select sectors of the market are assuming earnings that may not be realized until 18-24 months out. If true, this may be problematic in the short-term and certain segments of the market may appropriately enter correction territory. On the other hand, we know from Federal Reserve Chair Jerome Powell that he believes economic growth is likely to be very strong over the next 12-24 months, as are improvements in the labor market, amidst subdued inflationary pressures. This is something we have extensively discussed in our commentaries over the past few months.  Be that as it may, is it possible that the stock market has priced-in future economic improvements, and earnings, too fast? The answer is maybe, which is why we think the potential for a short-term correction of 7-10% is possible, not to mention very healthy. For those of you that were previously convinced a market correction was imminent (prior to reading this), do not take this commentary to be a confirmation to your potential bias in wanting to exit equity market participation. I believe the nature of any upcoming market correction will be guided to sector specific risks more so than ever before. Dislocations on earnings expectations, relative to stock prices, exist on a segmented basis today more so than we have seen over the past three years. We believe that remaining opportunistic and appropriately diversified in such an environment may amplify a portfolio’s success over the next 3-5 years (thinking long-term, not short-term). We are also very cognizant of what a potential market correction means. The ‘market’ is comprised of thousands of stocks across a variety of sizes, all of which are likely to behave different over the next 24 months. This will be a function of consumer health, consumer spending habits in critical cyclical segments, corporate earnings announcements, and overall investor sentiment. We are already starting to see impactful changes in various pockets outside of the main drivers of the S&P 500 and we look forward to improvements through the end of 2023. This may mean that the market’s impact from only the top names in the index may continue to shift in a healthy way.

I want to end this commentary by once again reiterating the notion that the market’s dynamic to the economy is very different and it deserves special attention when considering the backdrop of the past 12 months. If a market correction were to occur, I want to stress that its timeframe, depth, and longevity, are 100% unknown. Investors that choose to exit equity market participation (for whatever reason other than one dictated by your financial plan) are likely to do damage to their long-term success. The market’s activity since March 2020 has been a historically proven testament to that and it is a message we were adamant about in our weekly video series during the depths of the bear market.

 

We remain committed, and focused, on the long-term and stand ready to implement our tactical adjustment plans in the event of short-term noise.

 

Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management

4/9/2021 Commentary

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Investment advice offered through CX Institutional, a registered investment advisor.

*Performance comparisons represent net return differentials between the Bloomberg Barclays U.S. Aggregate Bond Index and the S&P Target Risk Aggressive Index.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.

All other data, including returns, soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations. 

Small Business Optimism sourced through NFIB.  Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan. 

Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites.  Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.

Economic Policy Uncertainty data sourced from Bloomberg via The Baker, Bloom, and Davis Index.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changed in the aggregate market value of 500 stocks representing all major industries.

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