Tuesday, 16 June 2020

Wall Street Vs Main Street – The Unstoppable US Large Cap Stocks Supported by Fed’s Dovish Promise

Refer to part 1 here, a post I written close to 2 months ago to show the disconnect between Wall Street and Main Street. To a large extent, this disconnect means that the stock market is no longer directly proportional to the economy. Despite the ailing economic situation in the US economy entering into a recession with record high unemployment, the stock market continues to rise. The 3 major indices of NASDAQ, S&P and Dow Jones are only a few percent lower than its all-time high seen in February. All indices had stormed upwards >30 percent since hitting the low in March. In spite of more recent bad news such as, the continual rising number of corona-cases, the protest of George Floyd’s death and souring US trade tensions with China, the stock market seemed impervious to bad news.

RECAP PART 1

In Part 1, I mentioned that one key reason of the disconnect between Wall Street and Main Street is irrational exuberance of the stock market. This stems from the emotional-led overconfidence and greed of human traits that fail to consider appropriately the upside reward and downside risk. Other reasons include the ignorance of retail investors, fooled by short term randomness, low bond yield etc. For all that was said, I did highlight back then that nobody can foretell the future of stock market. Hence, for investors who have the financial capacity and knowledge to be a by-stander are also not wise. Rather, they should be able to pick up good stocks which will bring good long-term returns, and yet, be patient and spread out the investments over time.

The irrational exuberance was recently reflected by the share prices of Hertz. The car rental company filed for Chapter 11 Bankruptcy on May 22, and soon after the filling, Hertz share price free-fall from February peak of USD20 to a trough of USD0.40. But who will have thought that less than two weeks later, the share price surge higher than USD5.00 (>10x) and closed at USD2.83 last week. i.e. 700 percent increase since the bottom. Most financial experts attributed this exuberance to Robinhood traders.

Notwithstanding the craziness of Hertz share price exuberance,
most financial analysis so that there is no clear relationships between the Robinhood traders and the recent general rise of the US stock market indices. 


In Part 2 here, I will share my alternative beliefs for the huge disparity between the stock market and the economy.

MARKET DOMINATED BY LARGE CAPS TODAY

The wall street of today is heavily weighted towards a few number of companies, such as “FAANG” stocks which refers to Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX); and Alphabet (GOOG) (formerly Google). The combined market cap of these 5 stocks are slightly over USD4 trillions in Jan this year. Half a year later today, while the global economy is suffering from the damages caused by the corona-virus, the FAANG stocks are oblivious to the global pandemic and rose another close to USD500 billions in market cap. i.e. FB ~650B; Apple 1.5T; Amazon 1.3T; Google ~950B and Netflix ~200B. For comparison sake, Singapore entire stock market capitalisation today is over USD500B, pale comparison to even just Apple or Amazon who each has trillion of market cap. Aside from FAANG stocks, the general indices in US are dominated by many other Large Cap companies in the tech-space of digital and cloud, pharmaceutical, energy and established essential services. The stronger and bigger companies are seem destined not just to survive but also to prosper over long term.

GREATER DISPARITY BETWEEN RICH AND POOR

The sector of the economy that are hardest hit are the medium and smaller companies who are not significantly represented in the major US stock indices. Analogous to the virus killing statistically more older people and those with inherent medical conditions, the economy is annihilating the smaller, weaker and outdated companies. 

To a large extent, the wealthiest people are those who have the largest stake in the stock market or own companies that are large cap listed publicly. These individuals will only become richer and will be the least hurt by the poor economy. They will be in a much better position to ride out the crisis and emerge stronger. The poor will become poorer losing their jobs and struggling with means to survive even in their daily life. If there are bad news causing a depressed stock market, the wealthy investors with their huge cash war-chest will be able to seize the opportunity to profit from the low stock prices. The poor employees who are in need of cash in a stock market crisis will be left not only licking their wounds on their depressed portfolio, but having to sell stocks at losses to raise cash for daily survival, after facing imminent job losses. Bill Ackman, the billionaire founder of Pershing Square Capital Management turned a USD27 million position into USD2.6B during the corona-sell down in March through defensive hedge bets.

MORE LONG THAN SHORT - ESPECIALLY ON LARGE CAP TECH STOCKS

The wealthiest are also usually immensely long in the market, meaning holding on to their fundamentally sound large cap stocks over a long period of time. Legendary investor Warren Buffett amassed a huge part of his fortunes through the buy-and-hold approach. Carl Icahn, another billionaire investor said in a recent interview that his most profitable bets are often those stocks where he has kept for a much longer period.  

And while Warren Buffett use to avoid Tech Stocks but nowadays He loved it. Buffett’s Berkshire own 250 millions shares of Apple Inc worth USD78 Billions today. It is Berkshire’s largest shareholdings with overall average pricing of ~USD140 per shares. Buffett also increasingly bought more than 500,000 Amazon shares last year. Amazon stock is up about close to 500% in the past 5 years. Buffett discussed the investment in a CNBC interview, explaining that though Buffett himself didn't execute the buy, he said: "I'm a fan, and I've been an idiot for not buying." Warren Buffett and his partner Charlie Munger also cited that one of their biggest regrets was not buying shares of Google owner Alphabet Inc.

Both Buffett and Ichan made huge profits out of Apple shares they owned. It was reported that Carl Icahn sold all his Apple shares to realise a USD2B profits in Apr 2016 with Apple stocks trading under USD100. If he will have keep his Apple shares until now, he will not have lose out additional several billions more of profits. Apple is trading at more than USD300 per share today.

MARKET IS FORWARD LOOKING WHILE ECONOMY LOOKS BACK

The stock market price of today is determined by expectations of the future earnings of corporations and individual consumers. Investors estimate prices of stocks based on earnings forward, say 6 months, 1 or 2 year or beyond. If there is any unexpected news good or bad, happen along the way, prices will be discounted accordingly. On that basis of forward looking, investors will have think that by that point in the future, the virus would probably have been brought under control. Whether it is V or U-shaped recovery, it does not matter anymore, because the market will be at the upper end of the curve with investors making good returns.

On the contrary, the economy looks backward using historical data to provide measurements of economic health. For e.g. it took at least one month or more (for revised forecast) after the covid-19 became a global pandemic before economist gave their forecast or figures with certainty of a global recession. When the corona virus started in December in Wuhan, IMF in January projected global growth to be 2.9 to 3.3 percent. In March, after the epidemic become pandemic, IMF then revised growth forecast of 2020 in April to -3 percent. The latest report expects that IMF is set to further cut global growth outlook for 2020, announcing by end June.

Therefore, consider  the bear market has a duration of one year, by the time economists announce recession, the bear market will already had started for 2 to 3 months or more, and by then the forward looking investors will already been buying back stocks progressively or significantly. Hence it is certain to see the disconnect of higher stock market and bad economy data.

FED PROMISE TO SUPPORT THE MARKET AT ALL COST

Last but not least, the biggest reason in my opinion for the market to be so confident is undoubtedly the US Federal Reserve (Fed) promise of “infinite” support of the market at all cost. How? The answer is simply via more and more money printing through purchasing of debts.

By end of April, the US Federal Reserve (Fed) had already pumped USD2.3 trillions into the economy throughout a six weeks period. US debt has already reached more than 26 trillions today and still rising. Note that the US has not only increased debts of US but also debts of the world. By end March, Fed announced that it will allow foreign central banks to temporarily swap holdings of US Treasury debt for US dollars. This means that for example, Singapore central bank owns US Treasury Bonds that has not reach redeemable date and is trading at a discount due to the crisis. And if Singapore is in desperate need of dollars, instead of selling the Treasury bonds at a bargain, the Fed allows Singapore to exchange the Treasury debt for cash without discount. Essentially it is more printing and lending of more US dollars to foreign nations from US.

The recent June Fed’s message also showed long-term commitment of zero interest rates through to 2022. Fed chairman Powell said “We’re not thinking about raising rates….we’re not even thinking about thinking about raising rates.” This he said is to support the economy and to keep unemployment below 5.5% and, inflation in check below the 2% target.  The Fed also announced that it would continue to buy Treasury and mortgage securities of not less than USD80 and USD40 billions a month respectively.

CONCLUSION

It is a sad reality, but it is almost poised that in the world of today, the rich and strong will become richer and stronger and the poor and weak is destined to become poorer and weaker. Wall Street is almost the place for the wealthy and knowledgeable to become wealthier. In contrast, the poor economic conditions will inflict more sufferings for the underprivileged.

That said, it is not all-win for the rich and strong of today if you are proud and arrogant and merely think about your own interest, without lending a helping hand to the community who are deprived. I believe the wicked will eventually suffer in the long term if not for wealth, but also in relationships and health.

Similarly it is not all doomsday for the poor and oppressed. Be righteous at all times, review your mistakes and repent, and do not give up learning and improving yourself. Your justice and blessings will eventually come. And by that time, do not be led-astray and be proud, but be humble at all times, and help those who are poor and oppressed.

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