The Stock Market: Rocket or Rollercoaster?

Dan Wiener:

The stock market’s been a rocket this year, rising more than 20% without even one 5% pullback. But has it really been smooth sailing, and are we headed for a bumpier rollercoaster ride in the final months of the year? Hi, I’m Dan Wiener, and welcome to another The Adviser You Can Talk To Podcast. I’m chairman of Adviser Investments, and today I’m joined by Portfolio Manager Steve Johnson and Director of Research Jeff DeMaso.

Jeff DeMaso:

Dan, Steve, good to be here with you both.

Steve Johnson:

Yeah, very excited to do this today.

Dan Wiener:

All right. Let’s talk. You guys live, you breathe, you sleep this stuff. I know you’ve both been worrying lately about how bullish the markets and investors have gotten. The S&P 500 index is up over 20% this year, which I think all of us would probably agree is a pretty darn good year, but I think what’s more remarkable, and I mentioned it in the intro, and Jeff, you’ve been pushing this for months now, is that we’ve earned those gains without even a 5% pullback. It isn’t like investors haven’t had a lot to worry about this year, from inflation to COVID to the storming of the Capitol. The big question I think on investors’ minds and ours as well is: Can this continue? Is the market on a rocketship higher, or are we on a rollercoaster about to take a plunge down? Why don’t both of you give some reasons why we could be on a rocketship and we could continue to gain some ground, and then let’s all talk a little bit about why it might be more of a rollercoaster. Steve, kick it off.

Steve Johnson:

It’s definitely been a rocketship. You look at stock prices and it seems like they only go from the lower left to the upper right and keep climbing. The fuel for that rocketship has been the liquidity that exists in the market. And what do I mean by that? Well, take a step back. If we look at average equity flows, what people were putting into ETFs and mutual funds over the last 25 years has averaged about $30 billion a year. If you look at that, I read this morning coming in that through August right now, we are approaching $700 billion in global equity flows. So it doesn’t take a lot to figure out why stocks keep moving up, because clearly there is a tremendous amount of liquidity.

Dan Wiener:

Sounds like TINA, Steve.

Steve Johnson:

Well, I don’t like that acronym, the whole TINA and the whole idea of zero interest rates, but it’s true. And the retail investors—Jeff, and you’ve talked about this—we look at Robinhood, all these different apps, whether it be the meme stocks, too, people are trading in this market and they’re putting money into the equity market. And not only has it been the retail investors, but we’re looking at buybacks, even, so that the whole idea of corporations flush with cash we’ve seen through August—buybacks are back to where they were in 2018, and we’ve seen close to $700 billion this year. Companies like Target, initiating a $15 billion buyback in August, which is about 12% of their outstanding shares. I think that’s been a big driver so far, that liquidity.

Dan Wiener:

We should tell our listeners, if you’re not familiar with the acronym TINA, it refers to “there is no alternative.” It’s been the acronym that has driven this thought that, because bond yields are so low, really investors have no place to go but to put their money into stocks. And I think what you’re saying, Steve, is corporations have felt like they have no better place to put their money than into their own stocks.

Steve Johnson:

Right. And I think that’s fueling it. And again, it’s probably, to your point about the rollercoaster as well, that that’s the risk issue, too, because perhaps people are taking on some more risks than they should because of the fact that you mentioned—that interest rates are extremely low.

Dan Wiener:

Jeff, you’ve been so quiet.

Jeff DeMaso:

I was going to say, let me pick up on that for a second. We can talk about allocation to stocks and the contrarian angle of that as well, but before we do, we’ve mentioned low interest rates a whole number of times here. Well, we often say that the other driver of equity returns are earnings. We say earnings and interest rates drive equity markets. And interest rates are low, so that makes stocks look relatively attractive, but also keep in mind that earnings are growing. Now the year-over-year growth rate of earnings, looking at the second-quarter numbers, are pretty much off the charts. Earnings effectively doubled year-over-year, and that’s not going to be sustainable. That’s just because we’re comparing to that depressed level from when the shutdowns were most extreme, when COVID first struck our economy and markets and our behavior.

Jeff DeMaso:

But nonetheless, even if we’re not going to grow at that pace, earnings are still expected to grow in the years ahead. So if you combine growing earnings with ultra-low interest rates, that’s some of the fuel for higher stock prices.

Dan Wiener:

Steve, you manage portfolios of stocks that pay dividends. Do you think that the dividend yield on these stocks is also driving the desire to buy stocks versus bonds to find some yield? We can talk about the risks of taking a strategy like that.

Steve Johnson:

Yeah, Dan, I think there is some truth to that. I think folks are looking, and we’ve seen it over the last month or so, this move to what we would consider to be blue-chip-quality names that people are very comfortable owning over a multi-year period. And to your point, these companies are raising their dividends. A number of companies in our portfolio have raised their dividends by 5%, 10%. So if you’re talking about inflation and you’re talking about how do I compete against that, well if your company is raising their dividend by 5% a year and let’s say inflation is at that level, that’s how you’re competing with it.

Steve Johnson:

But I think there is that piece of that, where people are looking to own high-quality dividend names, but to Jeff’s point, the earnings have been fantastic, and that has been the driver as well. I think a lot of people, me included, probably underestimated the strength of those earnings. And I think that’s the bull/bear debate now going forward: What does the future hold in the fourth quarter, in the first quarter of next year, for those earnings and the growth rates?

Dan Wiener:

Well, we got a surprise on jobs last Friday. Jeff, I know that you’ve been talking a lot about the Fed being accommodative. So have you, Steve. And given that the jobs numbers were not what had been expected, do you all think that the Fed keeps it lower for longer?

Jeff DeMaso:

I think part of that bad jobs number pretty easily pointed to COVID as the culprit, and the delta variant in particular. I mean, the numbers out of the service sector, restaurants and the like, were pretty bad. So, maybe the Fed holds a bit longer, but probably the length of time that they’re holding is dictated by the current wave of the virus and how long we continue to not go out as much and not fly as much, which we’ve seen in some of the high-frequency data—that people are going back into their shells a little bit on the margin.

Dan Wiener:

It’s funny you’re talking about the high-frequency data, because I want to take the other side of this, the rollercoaster side for a minute, and say I think we’ve actually been on a rollercoaster all along, but the ride has looked smooth because of the dominance of the large-cap tech stocks, the stocks that have really driven the S&P index, for instance, to its highs. But forget the stock market for a moment, look at the high-frequency data, which is telling us what’s happening today, or what’s happening in the last couple of days. There are a lot of popular metrics, like seated dinners, courtesy of OpenTable, and how many people, as you said, are flying, based on the TSA data. But the stories they tell are almost as much on a rollercoaster as some of the other underlying issues in the stock market.

Dan Wiener:

A week ago, the numbers did not look very good. This week, they look good. Maybe it’s Labor Day, but we had Labor Day in 2019 as well, which is when most of this data is now being compared to. I think you have to be cautious. We like using the high-frequency data. On the other hand, we have to be cautious because the stories that it tells change so quickly. Steve, let’s discuss the other side of this. Let’s talk a bit more about the rollercoaster.

Steve Johnson:

Well, I think you nailed it right there when you talk about some of that high-frequency data, because there has been a lot of—and Jeff mentioned it about the jobs number—the impact of the delta variant over the last month. I think a lot of people are saying well, once this peaks, we’ll get back to normal, and we can see economic growth pick up again in the fourth quarter. That’s where I shake my head a little bit because if you look at some of the data recently, we look at auto sales, for example, which have not been robust over the last couple of months, we’ve seen a lot of pulled-forward spending. We’ve seen it even on the Peloton earnings, where people went out during the pandemic, they either bought a Peloton—a lot of people purchased that house. So there’s been a lot of spending that occurred early in the pandemic.

Steve Johnson:

Now the question is: What happens going forward? And don’t forget, as of today, we’re seeing quite a few people will no longer get that extra $300 per week. So we’re talking the loss of roughly $170 billion of income support. Now you have this question: Will people come back to work? Will we see this growth trajectory that we’ve been on, will it continue? Now as I mentioned, the data recently has turned over, things like the Citi Economic Surprise index. We’re starting to see some weakness in the economic data. And again, is that delta-related or is this a change in the economy which leads the Fed to be—perhaps they need to be—more accommodative for longer. And that’s I think the debate that we’re going to have over the next month, especially if we continue to see some weakness.

Dan Wiener:

Valuations are high. Historically we typically get intra-year market declines of 14%. I don’t know. I think I’m hearing rollercoaster here. Jeff, what about you?

Jeff DeMaso:

Yeah, I would agree. I mean, you hit on that number of 14% intra-year declines. Part of it’s just history. We know the market doesn’t just go up. We regularly get pullbacks and corrections. It’s part of being an investor in the stock market—seeing through those time periods to know you’re getting higher down the line. I think, to bring it back to one of Steve’s early points about how much investors are moving into the equity markets, we can look at investors’ allocations to stocks. It’s at the highest level it’s been since the tech bubble, really. It’s almost not quite at that level, but it’s getting there. I see that as a bit of a contrarian indicator.

Jeff DeMaso:

Whereas if everybody’s already bought stocks, then who’s going to be the next buyer? And maybe it doesn’t take much to spook some of those recent investors in stocks or traders in stocks, if you will, that when prices start to go down, they quickly realize that stocks don’t just go up, and they might panic a little bit, and that can compound some of the potential selling. Maybe that’s what gets us that average market decline this year—people get a bit spooked when stocks actually do decline a little bit.

Steve Johnson:

Jeff, I think that’s a great point. The other point I don’t think that we’ve talked about really has been the political landscape as well. The other part of this going down to the end of the year—

Dan Wiener:

Steve jumping on the third rail here. Okay.

Steve Johnson:

Well, I didn’t want to go there, but I just think there’s been so much in the news. I don’t even want to have to talk about the Supreme Court last week, but these are huge polarizing issues. The question about infrastructure spending and also corporate tax hikes: We talked about earnings. Would a corporate tax hike going from 21% to 25%—would that have an impact on earnings going forward? And of course we could be talking about politics for the last 20 years, and we know that it’s terrible to base your investments on your political views because we know how disastrous that’s been, but understanding it could have an impact on the economy here as we head into next year. I do think that is one piece of the puzzle that exists out there that may create a little bit more volatility as we go forward.

Dan Wiener:

Yeah, but I think we need to talk more about what’s going on inside the market. As I said at the beginning, the S&P has smoothed over a lot of the turmoil, the ups and downs, the rollercoaster, if you will, inside the market. I mean, I made a quick list the other day—the meme stock situation this year. SPACs. I mean, has anybody heard about SPACs lately, except for the fact that they’re all doing terribly? I saw an analysis by JPMorgan. Most of them have lost money for their investors, all except the sponsors. It’s the sponsors who make the money. Everybody else seems to be losing money in SPACs. Things are getting worse, not better, in the SPAC-iverse. And all of a sudden they seem to be off the table, but boy, there was a lot of momentum and a lot of turmoil over there.

Dan Wiener:

And then I would just caution people. The snake oil merchants are out in force. I mean, I get emails every day promoting 10x winners and hundreds of triple-digit winners. It’s all lies. The latest now are the BNPL stocks, the “buy now, pay later” stocks. The only thing that investors are buying here, I think, is promises that are going to go unfulfilled and that, yeah, they’re going to pay for it later. And then you guys haven’t even hit on crypto. Crypto, bitcoin, hit a high in April, then lost more than half of its value by July, and now it’s up 75% from that low. I mean, this is not investing. It’s speculation. And yet this is the headline stuff.

Jeff DeMaso:

Well, Dan, I could add a few more to that list as well. And to your point about the S&P being smooth on the surface, we’ve seen big shifts in which sectors are in favor, or if you want to talk value stocks versus growth stocks, we’ve seen a big swing there, or how about China. I mean, their market’s down 20% or 25%. That’s been on a rollercoaster. So I agree with you that the S&P might look like it’s on a rocketship, but there has been a lot of rollercoaster action in plenty of other parts of the market.

Steve Johnson:

Your point about large-cap dominating this market—I think investors have totally misunderstood how strong this market has been to that point, because the S&P is making new highs, but as you and Jeff just mentioned, whether it be SPACs, cannabis, meme stocks down 40%, 50%, I’m not sure there are a ton of people who proclaim they have diamond hands and hold on all this time. I think there’s been a lot of volatility and a lot of losses in those sectors. I guess the question is: Is it different this time? Can technology continue to lead? There are a lot of folks out there who believe that this is a new growth environment with the technology that we have. And in an economy that perhaps is slowing next year, we know there’s a lot of money that’s been going into those names that people believe will lead us in terms of productivity and technology.

Steve Johnson:

So again, if we look at valuations, the growth names are probably expensive, but again, they are the ones that are growing at a much faster clip than the rest of the market, and that’s where investors have put their money. We’ve seen that over the last couple of months, we’ve gone back. We had this reflation trade where people bought energy and commodities and industrials. Over the last month, not so much. Over the last month, people have gone back into tech, back into biotech, health care, things that could do well in a slowing environment. So yeah, even though the S&P has been a smooth climb, the movements among sectors, it’s just been tremendous.

Dan Wiener:

I love getting together with you guys. It’s really fun. But I’m going to take us out here because I think it’s important for people to take the highlights and go off and make sure their portfolios are in good shape. So if you’re like me, your portfolio’s probably never been bigger. Prices are at or near all-time highs, but I think it’s important to recognize that a pullback could come at any time. And with that in mind, it’s crucial to stick with your investment plan. It’s easy to stay invested when markets are going up, and it’s a whole lot tougher when they go against you. And as I like to say—you guys have heard me say this too many times, I’m sure—when either a market index or a stock or your portfolio’s at an all-time high, there are only two things that can happen tomorrow. You’re either going to hit a new high or you’re going to “lose”—and I put that in quotation marks—something from that high.

Dan Wiener:

I hope we’ve been able to shed a little light on why we think the rocketship has turned into or is about to turn into a rollercoaster in the months to come. I want to thank you, Steve. I want to thank you, Jeff. Anything you want to add before we end here?

Jeff DeMaso:

I think the only thing I’d add, and it just reiterates your point here, is remember that the rocketship and the rollercoaster analogies are not perfect, particularly the rollercoaster. When you get on a rollercoaster, it takes you on a crazy ride, and then you get off pretty much where you started. You don’t really go anywhere. But the market is different. You get paid for all the ups and downs of the market that has gained ground over time. It, in other words, takes you somewhere. So it’s a bit different than just hopping on a rollercoaster and then getting off all wobbly legged where you started. You end up at a better place.

Dan Wiener:

Great. Thanks, guys. This has been Dan Wiener, Steve Johnson and Jeff DeMaso from Adviser Investments. I want to thank you for listening to The Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback really is always welcome. If you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. And once again, I’d like to thank our incredible team of Kailey Steel and Ashlynn Melvin for making this podcast a reality. And thank you listening.