Two years on from the pandemic’s dawn, and pundits remain blind to its biggest lesson: Don’t fight the market. It is right much, much more often than all those who keep arguing it is wrong.
That crowd has been wrong at virtually every turn over these 20 months, since stocks bottomed in the short, painful, lockdown-induced bear market. A big rally despite COVID’s spread and persistent lockdowns? “The market is wrong!” Then it was “wrong” that growth stocks were leading off the lows instead of value, a mistake vaccine rollouts would surely “fix.”
Next stocks were “wrong” to overlook the contentious presidential election and January 6. “Wrong” to rise through winter lockdowns Mak-II and the Delta variant’s later surge. Rising stocks and low bond yields are “wrong” about the Fed’s quantitative easing taper and elevated inflation. And supposedly wronger longer as they power through supply chain catastrophes, labor shortages and vaccine mandate chatter.
This craziness must end sometime, surely--no? No. It isn’t craziness. It is right.
Yes, in the very short term, markets can seem quite irrational and inefficient. That is where bubbles and panics alike seemingly come from. Like Ben Graham said, stocks are a voting machine in the short run—about popularity. But in the intermediate to long run a weighing machine…weighing fundamentals….relatively rationally and efficiently. And more rationally and efficiently than you and I can. That is what we have seen these past two years, as stocks priced what pundits couldn’t envision. And maybe you couldn’t.
And, of course, stocks legendarily pre-price all widely known information and opinions, no matter how smart we think we are. And the pundit and grouser crowd’s information and opinions are always widely known and discussed—hence priced.
So to get ahead, shift your focus. Assume the market is basically right andefficient, not irrational and wrong. People, many very smart people, will call it reckless and foolhardy, but it is the wisest, most time-tested way to navigate the market and reality. To see it, just flip all of these events on their head.
Start with stocks’ initial rally in late March 2020. Stocks rightly jumped fast off the low since nearly everyone could see and understand the bear market’s cause near-immediately—and estimate the associated economic damage. Unusual! There was no uncertainty about the downturn’s main driver. It was lockdowns, full stop. The fallout was obvious nearly instantly. That let markets price the damage faster than ever. It also gave stocks a clear view of what would end the carnage: reopening. Even without a precise timetable from the government, stocks subconsciously understood a reopening would come before long. They were right.
Growth stocks’ leadership was right, too. Putting the economy in a medically induced coma didn’t reset the economic cycle that began way back in 2009. It simply put it on ice, ready to resume close to where it left off once lockdowns ended. That meant stocks naturally behaving as they do in almost every maturing expansion, which is when growth usually leads.
Moreover, growth stocks were simply positioned better than value to weather the remaining ongoing issues. Their fat gross margins were shock absorbers. They concentrated in sectors and industries that were lockdown winners thanks to e-commerce and remote work. More economically sensitive value stocks have thinner gross operating margins and smaller cash cushions and rely on debt financing. They face headwinds that few appreciate to this day.
Stocks have been no less rational over this past year. Looking past the election was utterly right, considering the gridlock-lite the election brought. This legislature is among the most do-little in decades, and audacious proposals seemingly die daily. Look how watered down the infrastructure bill became from initial proposals—only about $550 billion in genuine new spending–much of which may never get spent. It spreads spending over more than the slated five years, considering permitting and construction timelines. The social spending bill has shed programs and tax hikes alike—with more to come. The longer it drags the smaller it gets—if it passes at all–and if it isn’t re-negotiated by future congresses which it almost surely will.
The Delta variant? We now have data galore showing it didn’t stop the recovery when it supposedly ravaged the Sun Belt this the summer. That offers an approximate blueprint for any wintertime surges in California and northern states. That stocks correctly didn’t tank on Delta’s rise should prove beyond a shadow of doubt in the dark and dreary minds’ of the pundits and grousers that lockdowns drove 2020’s early-year decline.
The supply chain crunch? Q3 earnings reports show stocks were dead right to rise through it. S&P 500 earnings soared far past expectations. Gross margins stayed resilient in all sectors, with Tech and Tech-like Communication Services leading the charge. This, too, stocks already told you about, as growth has led value by a mile since mid-May.
Inflation? Stocks aren’t wrong to rise through it—again, see earnings. Consumers hate it, but businesses have pricing power. That preserves margins as prices rise, making stocks a hedge against the kind of initial inflation hiccups we’ve encountered. Nor are bond yields wrong to stay low, as high inflation comes from the supply crunch—temporary. After one-off price jumps flow through the economy, inflation eases as prices rise more slowly off a higher base.
QE tapering? It proved fine for stocks in 2013. Relatively efficient markets know this, too. Trust them.
Stocks constantly size up all of these and more, registering the likely outcome in prices. Those prices are the best darned single signal of reality extant. So don’t pooh-pooh markets. This Thanksgiving, show markets some gratitude and love for their hard work. And listen closely in the New Year. There is an aged saying seldom heeded….”The Market Knows.” And it knows more than you and I do, thankfully.