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Covid 2.0?


Chief Strategist at Interactive Brokers

“Be fearful when others are greedy” is a famous maxim coined by the esteemed investor Warren Buffett. Equity markets appear to be blithely ignoring local and international events, leading me to coin a new corollary: “Be fearful because others are greedy.”

Much of the recent rally in stock prices has been predicated on the idea that we have been flattening the curve; that the international efforts including lockdowns, quarantines, and social distancing had their desired effects to put the worst of the Covid-19 crisis behind us. I have become quite concerned that the events of the past few days have unraveled much of that progress.

Like nearly everyone in the US, I have watched the protests in our major cities with a mix of shock, sympathy and alarm. But let me be quite clear here – my mandate is to discuss markets, not politics. Thus any analysis and opinions in this piece are intended from an economic and market viewpoint. Regardless of my personal views on the civil disobedience and violence, I believe the markets are not fully acknowledging the risks that could accrue from this activity.

It has been my experience that market participants and markets as a whole are woeful at pricing geopolitical and other exogenous risks. Markets are terrific at discounting events that influence the fundamentals of equity pricing – earnings, dividends and cash flows – but have a much more difficult time understanding how world events affect those key variables. Markets were late in recognizing the risks of coronavirus, rising until mid-February in the face of a spreading plague and reacting only when it became glaringly obvious that drastic measures that would affect the broad economy would be necessary. At that point seemingly every pundit became an amateur epidemiologist (guilty as charged), opining about how the path of the virus would affect the rate of economic recovery. The consensus arose that the worst is behind us, and that the fiscal and monetary stimuli would effectively immunize the economy from further damage.

I now have to question that sanguine consensus. We witnessed thousands of people in close contact, many of them unmasked, in urban areas around the country. Once again, I stress that this is not about the causes of the protest, but about a potential unintended consequence that could affect the economy. We have already seen increasing infection rates in areas of the country that had begun to reopen, and now I am concerned that we may see a bounce in areas that had seen progress. I can only hope that I’m wrong about this, or at least that any return of the virus is minimal.

We also need to question how this will affect people’s ability to return to work. Anyone who worked at a looted business is now likely unemployed. Many of these are small businesses, however, and we have been reminded numerous times in the past few months that major market indices only include the largest business. Large companies, like Amazon (AMZN), Target (TGT) and Apple (AAPL) have announced that they are reducing or closing operations in affected areas, but many of those companies are higher this morning because the closures are deemed to be minor and temporary.

Even a wide range of property/casualty insurers are trading higher. One would expect that their adjusters would be barraged with claims this morning as a result of the widespread damage caused by rioters and looters. Yet there is virtually no news on insurers, let alone any significant market reaction. Can this really be treated as business as usual? There is a known phenomenon of insurers rallying after a natural disaster on the basis that they will now be able to raise premiums across the board. But this is neither a natural disaster, nor do I see any consensus about the ability to raise rates. It strikes me simply as markets acting as though little has changed.

This business as usual mentality now strikes me as a risk in and of itself. The S&P 500 Index (SPX) is at a level from November, the NASDAQ 100 Index (NDX) is flirting with all-time highs, yet the vast majority of companies are looking at weaker earnings and dividends. There are three likely explanations for this performance: either (1) markets have unwavering faith that the Federal Reserve has extraordinary powers to keep markets humming, or (2) they expect an economic recovery fast enough that our companies will be back on track in a matter of months, or (3) investors have gotten way ahead of themselves. Investors need to ask themselves how much faith they have in a central bank as deus ex machina, and whether the events of last weekend will affect major companies’ ability to recover unscathed in a short period of time. Any concerns about the first two factors likely require investors to consider the third possible explanation.

I started this piece with an adage, and I’ll end it with three. “Don’t fight the Fed” has been the market mantra, but we seem to have lost its codicil of “but you don’t have to join them.” And for those market timers, remember “markets can remain irrational longer than you can remain solvent.” This strikes me as a time to manage risks and exposures, and a potentially opportune time for profit taking. “No one ever went broke taking a profit.”

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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