Some quick reminders before we get into it since there are more of you reading this now than there were last week. First, this is my diary on the market. It is in no way shape or form investment advice. These are the conversations that I am having with myself as I take in all that is happening in the market while trying to square it with the prevailing narratives and fundamentals. I do this to give some clarity to my thoughts. If you like what you are reading, please consider passing it along to others who might like it as well.
Next, if you have an opinion, I would love to hear it, especially if you disagree with something that I am thinking. I promise you that after starting in this business as a summer intern at the New York Stock Exchange when I was 16 years old, I have extremely thick skin.
John Templeton once famously said, “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.”
In 2017, the S&P 500 did not register any pullbacks that were greater than 5%, it was a nice steady climb higher. All you had to do was be invested in the market and you were making money. The market and investors were euphoric on the thoughts of tax cuts and a better regulatory environment ushered in the with election of President Trump in 2016. President Trump’s tax cuts and the Jobs Act of 2017 were signed into law on December 22, 2017. You can read all about it here.
As 2018 began and progressed, equity markets continued to set records. Then in the fourth quarter of 2018, the road became a bit bumpy for global markets. As investors moved through 2018, it was becoming clear that the rest of the world was slowing down. Also, a year had now passed since the enactment of President Trump’s policies. Investors tend to make comparisons on the year over year basis. As we looked forward to 2019, growth in the US would begin to slow as well, purely as a function of having difficult metrics to try to beat as the impacts of the tax cuts were lapped.
The rally in 2017 and the first three quarters of 2018, in my opinion, were the euphoria phase on which a cyclical bull market died. Now, anyone who only looks at the S&P 500 and the Nasdaq will argue that the bull kept running until February of this year and ended with the pandemic. I am going to argue that the bull market ended in 2018 and that the COVID pandemic created a capitulation low and the environment of pessimism required for the next bull market to be born.
Think about how you felt in March when the virus was raging…that’s when the market bottomed. Think about how you felt over the summer when your normal activities were different this year. Think about how you feel now. Cases are rising once again. You are probably getting ready for the holidays, starting with Thanksgiving, to be a bit different as well. My daughter’s won’t be performing in the Nutcracker. There will be fewer people around the table wherever and for whatever we are celebrating. We are wondering if we will ever get back to the way it was before. Turn on the TV and you see protests, some peaceful some violent, and you wonder how long this will all last. I know I have caught myself wondering how this could possibly end well. This is pessimism. COVID and the drastic changes that it has pushed on all of us has created an environment where it may be perfectly reasonable to feel like things are never going to get better.
But guess what? The market is trading at a new all-time high. And in this case, I am not talking about the S&P 500 or the Nasdaq, the averages that hold the biggest and most successful companies in the world. No, instead, I am talking about the Russell 2000. This is the index that tracks the smallest stocks listed in the US. These are the stocks that, in my mind, paint the picture of what investors think the real economy is going to look like in the future. The fund that tracks the Russell 2000 (IWM) made a new high in August 2018, after the tax cuts and the Jobs Act were signed into law and euphoria took over. It then dropped violently between October and December 2018 as slowing grow was priced into the market when investors realized the comps were going to be tougher in 2019. In February of 2020, this fund did not make a new high as the S&P 500 and the Nasdaq did…the real economy was still struggling. Enter COVID and the fund plummets to a closing low that was more than 40% below the closing high reached in 2018.
I know it doesn’t feel like it now, but I think the case can be made that a bull market is just beginning, born on the COVID pandemic and the pessimism that it has introduced into the lives of many.
I write a more detailed note everyday. Find out more about it here.