Fueled by an unprecedentedly massive amount of monetary stimulus, Wall Street took off like a scalded cat in April, with a fully diversified equity portfolio up nearly 12%. Much like other ‘reversion’ rallies that had followed previous waterfall decline bear phases, it was the stocks and sectors that performed the worst during the steep decline that turned around the most. The notables that roared higher include retailers (+24%), banks (+18%), homebuilders (+20%) and most especially energy stocks which, even with historic declines in the price of oil (more below), have rallied nearly 25% since the end of March. Also playing a major role were the five largest companies – Apple, Microsoft, Amazon, Facebook and Alphabet (Google). More on that below.

Best rally in more than 75 years

The data since the low on March 23 has been even more impressive. In fact, the rally in the last 25 trading days has been the best in more than 75 years! When compared with twenty-two prior Stage 2 Bear Market rallies, if indeed that’s what this proves to be, the magnitude is more than double (35% versus 16%) in only 25 days, versus the usual 35.

But that’s the markets…

As for economic fundamentals, it’s of course miserable out there. Unemployment claims, industrial production, retail sales, housing data – all that and more have plunged. Next Friday’s unemployment number will most certainly be historically hideous. It’s still all about the virus and only about the virus. There are no other headlines that matter. Perceptions about its magnitude and duration change constantly. Lately, whether real or imagined, there have been some glimmers of optimism, which the financial markets have glommed onto. More on that below.

Impact on Corporate Profits

Any normal May Update of mine would contain all sorts of information and insights about the magnitude and direction of corporate profits. Yes, Q1 earnings are being reported, but unless a company is judged to be on the front lines of servicing an isolation-bound economy (think Amazon and Facebook), its earnings report is basically irrelevant. However, dividend policy is now of vital importance, particularly since many long term investors have turned to common stocks to generate current income, since interest rates on high quality bonds have declined so steeply over the past five years. So far, there have only been a relative smattering of dividend cuts and suspensions. And those stocks have been hit quite hard. Should that become widespread, that will be a problem, well beyond the ‘trading market’ environment discussed fully below.

So why did we have the best month for stocks in decades?

Plain and simple - over-the-top excesses in money creation. Last month’s Update noted that the Federal Reserve had already initiated eight major stimulus regimens. We can add several more to that. Some $3 trillion has been made available to the economy and the financial markets within the banking system. Add to that the now-$1 trillion-becoming-$2 trillion paid out to taxpayers and business owners through CARES and the two PPPs (Payroll Protection Program). Since cash is the fuel that drives the economy, it should be party-time, right??

But, but, but….aside from maintaining a very basic amount of isolation-based economic activity, our virus-infected economy has no interest whatsoever in using any of that new money. You couldn’t take a trip to Disney, ski the Himalayas or even dine at a five-star, even if you wanted to. So guess what…if the economy has no interest, the high octane traders will happily gorge on it. This is what they live for - access to a virtually unlimited supply of capital, with no cost of carry, and very few other market participants to compete with. Traders care about one thing and one thing only – “is my stock on the move?” In April virtually every move was higher and higher and higher.

Furthermore, and as also noted in last month’s Update, these monetary stimulus programs aren’t likely going away anytime soon.

These traders aren’t going to wake up tomorrow or any time next week and find that their treasure trove has been eliminated by a policy reversal or overtaken by an economy that overnight decided it really can use that cash after all.

But there’s a catch. Once a bear market hits bottom, with all the despair and negativity vastly more than fully discounted, when every potential seller has sold, stocks don’t magically re-levitate. It requires cash to buy them. And the ensuing rally requires more and more cash to sustain them. Cash and only cash is both necessary and sufficient. But at some point, after stocks have taken a massive turn higher, though cash is still necessary, it’s no longer sufficient. No matter what the catalyst, all bear markets occur because of a feared impending recession. In order for the bear to fully end and a bull market to become fully sustainable, there must be an equally sustainably fundamental back-story of a strong economic recovery behind it. Not just one of hope and desire, but of real substance.

Of those 22 above-noted prior bear-market rallies since 1950, six others advanced 22-27% lasting 17-42 trading days, with the most recent being the 27% surge November ’08-January ’09. Their back stories weren’t then yet fully sustainable. So they all ran out of steam and in most every case (for all 22) stock prices fell back near to or, in that recent case most notably, well below the prior low.

The end is near for coronavirus? Maybe…but maybe not.

As we enter May, 2020, yes, there’s a back-story of economic recovery. Some states are beginning to re-open, but we truly have no idea. Without a cure/vaccine or even a real and widely available treatment, the virus will do what it’s going to do. It doesn’t listen to daily pronouncements. It doesn’t care what policymaker says on which day. It certainly doesn’t care about the November elections. Maybe the summer will bring a reprieve, or maybe not. Maybe it’ll come back with a vengeance in the fall, or maybe not. This cannot be repeated enough.

In my humble opinion, the fundamental back-story for the 33% reversion bull rally from the March 23 bottom to the April 29 top was based on the premise that the all-clear signal is on the horizon. But what if it’s not? What if instead of the all-clear being on the horizon, it proves elusive and might not happen until very late ’20 or even ‘21? God forbid, what if it gets worse than it already is?

Furthermore - yes, the economy will re-open someday. But even when it does, what will that look like? The Administration desperately wants it to go back to ‘normal’, i.e., just what it looked like in late January. And I think the rally was pricing that in too. But is that even remotely possible? The economic world changed considerably after the Great Financial Crisis of 2008-09. It changed a lot after 9/11. I can’t imagine that the post-Covid-19 economy won’t look massively different, in some ways we can’t even begin to forecast.

Back to the immediate moment. Things are still uncertain, no matter what you hear. It’s still a trader-based market and only a trader-based market. Traders trade – that’s what they do. They don’t care what they own and they honestly don’t care about what happened even five minutes ago. They only care about five minutes from now…and then five minutes after that. For virtually all of April, they used all that excess money to drive stocks higher. The higher prices certainly have allowed all investors to breathe a little easier lately. But since traders are just as happy making money on the downside – using that cash as margin power to ‘sell short’ - a trader-based market that rips higher can also rip lower. When the necessary fundamental back-story is as completely (and inconveniently) out of anybody’s control, and without prior precedent (as the virus fight is), it’s impossible to have any confidence in the near-term outcome.

This potential for a re-reversion selloff is exacerbated by the fact that the equity markets are so dominated by a relatively few number of stocks. The top five noted above represented more than 21% of the S&P 500 as April came to a close. This exceeds the 18% concentration by the top five in early 2000, the top of the dot-com bubble. Yes, I’ll accept the fact that the individual company fundamentals for today’s five are better than for those twenty years ago. But, as I just said, traders don’t care about that.

Though we made a modest addition to stocks back six weeks ago very near the March 23 low, thereby reducing our tactical underweight at the time, with this huge reversion rally we are in no hurry to do so again. But even with the continued virus-based uncertainty, we are not inclined to reverse that addition either. Continuing to ‘hide in the tall grass’ with plenty of buying power is where we are very content to remain.

We are planning a video-call on May 14th to address any and all ongoing concerns about the investment markets and wealth planning as the Covid-19 environment continues to evolve. Please be on the lookout for an invitation and please know we always welcome your questions and concerns.