Through every negative economic and market cycle, we are told “it’s different this time” and given reasons that each period is unique. One thing these time periods have in common … they ARE all unique. There are always reasons to not invest. Through these times, remember that the fundamentals of investing don’t change.
First, investment money will be somewhere.
Whether we participate in the equity markets, the debt markets, or buy rare historical artifacts, our money will be invested in something. Even choosing not to invest and holding onto cash is an investment decision. We can accept the risk that cash may be lost, stolen, or simply lose value to inflation over time. The choice isn’t whether or not to invest but where we choose to put investment dollars. That leads us to our second fundamental …
Investment returns are based on market participation.
Participants drive the forces of supply and demand. When willing buyers meet willing sellers, they settle on a price agreed to by both of them. When there is more supply than demand, buyers can make multiple offers to drive down the price. When there is more demand than supply, sellers can sell to the highest bidder. An investor in these markets is trying to get ahead of these decisions and invest in markets where demand will grow over time. If participants leave those markets, demand falls … and so do valuations.
Third, there is always somewhere to put money.
In any market, there will be winners and losers. It’s up to each investor to decide where their money will be best utilized. As economic and market conditions change, so do investment choices.
Let’s apply these fundamentals to the current markets.
There is a record amount of cash sitting idle in bank accounts and other cash instruments. Many investors are concerned about the future and taking a cautious approach. Since the Fed has lowered the Fed Funds Rate nearly to zero again, these cash positions are earning next to nothing.
Out of fear, many market participants left equities earlier this year and moved money to bonds. Demand drove up the value of bonds and drove down yields. From a fixed-income standpoint, there is very little income to be had in conservative fixed-income assets. Also, as income-seeking investors move money to where they can get a better yield, values may fall over time. This is a market where existing participants experienced strong positive returns, but the future is perilous for those who remain. The combination of current low-yields and future depreciation isn’t compelling.
The equity markets have been volatile and not for the faint of heart this year. Investors look to the future when making investment decisions. When the future was bleak, equity markets plummeted. Money leaving the equity markets drove down demand (and valuations) until an equilibrium was reached. Forward-looking investors then looked to a future where things eventually improve and bought shares in companies with positive outlooks. Market indices are nearly back to their beginning of the year values.
The investment markets most hurt were those most impacted by the COVID-induced shutdowns—areas deemed “non-essential”—primarily retail, travel, and hospitality. These account for about 20% of GDP and about 20% of employment. Some other areas are actually doing well—especially areas important to supporting families staying at home and working from a distance. Surprisingly, the more volatile technology-driven sectors, which usually suffer in times of turmoil, have increased in value significantly during this timeframe. It’s counter-intuitive that traditionally-more-volatile areas performed better than more conservative alternatives in these times of uncertainty… but it is rational.
A wise person said, “Markets are nearly always rational and logical. However, it usually takes hindsight to see it.” The rationality and logic of the markets is the culmination of the choices made by market participants. Shutting down the economy was unprecedented. Restarting the economy will be just as unprecedented.
There is a natural tendency to fear when the market drops and some euphoria when it rises. Trying not to react emotionally to either situation is challenging. These are normal movements of markets trying to find a direction based on the rational decisions of market participants. We are in a recession now. We don’t usually see it in real-time because it’s usually confirmed in hindsight. Knowing we are in recession means bad news isn’t surprising. Watch for green shoots of the coming expansion and make rational choices with investment assets. Don’t forget the fundamentals.