First of all, Max combed the trend of the S & P 500 index this year:
On February 19, the U.S. stock market hit a record high, with the standard & Poors 500 index at 3386. Then, investors began to price the new coronavirus, which led to the market entering the bear market at the fastest speed ever, and the S & P 500 index fell 34% in five weeks, hitting a record low of 2237 points on March 23. On the same day, the Federal Reserve announced unprecedented measures to deal with the economic stagnation caused by the outbreak. Since then, the stock market and the credit market have started to rebound on a large scale.
The world is fighting the biggest epidemic in a century and the worst economic contraction in more than 80 years. However, the stock market, a barometer of current and future economic conditions, has risen at a record level and is almost close to the peak of the pre outbreak and boom period. How could that be? Mark said.
He stressed that his purpose in writing this memorandum is to conduct a comprehensive analysis of the rebound, rather than to predict the future. So, first of all, he picked out some obvious reasons among a number of potential factors driving the market rebound:
1. Investors are very confident in the ability of the Federal Reserve and the Treasury to achieve economic recovery. Investors are excited by what the government did during the economic shutdown. Everyone knows that the recovery will be gradual or even bumpy. Few people talk about a strong V-shaped recovery today, but there is a broad consensus that recovery will be undoubted.
3. People like to think its all over.. Optimistic economic data also reinforce this conclusion. Given the unprecedented decline in this quarter, the next three quarters are likely to record significant month on month growth and a strong year-on-year growth in mid-2021.
In addition, investors are also full of expectations for the improvement of the future economic situation. True, both GDP and corporate earnings will decline sharply this year, but investors are beginning to be willing to predict that maybe by 2022, the full year earnings of the S & P 500 will exceed the level of 2019 and the previously expected level of 2020.
In a word, in terms of economic and business development, investors have come to the conclusion that everything is OK or at least moving in the right direction.
For example, in the week of March 23, you cant stand up to the Fed.. Clearly, the evidence has led investors to believe that interest rates will go according to the Feds wishes, and markets will go according to the Feds expectations. The higher the market, the more people believe that the Feds goal is to keep it going higher, and that it has the ability to do so.
Whats more, the Feds actions show that its not interested in ballooning deficits and debt, as long as it needs to, and its bond buying operations wont stop. And everyone believes interest rates will stay low for a longer time.
All in all, the Fed has created capital market conditions that have led to easy access to todays financing, record levels of bond issuance, and large oversubscribed transactions. As long as loss making companies can refinance their debt and borrow more money, no matter how bad their business model is, they are likely to survive and get out of bankruptcy. Zombie businesses and moral hazard dont seem to bother the Fed.
In addition, Max also believes that behavioral factors have a significant impact: index funds, ETFs and other passive investment entities account for a large proportion of transactions in todays market, once they are mobilized, these trends are likely to continue. In addition, investors are satisfied with the put option the Fed is offering, believing that the Fed has no choice but to continue to support the market. Therefore, the current market fear of missed opportunities mentality seems to surpass previous worries about losses, this change is crucial in determining market sentiment.
Retail investors have also played a great role in the rise of the stock market, of course, also contributed to the most irrational part of the stock market, such as the stock prices of some bankrupt companies rose sharply. This shows that the speculative fever in the market is rising and lacks careful analysis. In addition, it should be noted that at present, fundamentals and valuation are of limited relevance. Whether it is the beneficiaries of the epidemic or those industries that have been hit hard (such as tourism and restaurants), their stocks have rebounded significantly.
After listing all these positive factors, Max reminded again, dont forget that there are still negative factors in the market.. Specifically, the restart of the U.S. economy may lead to a second outbreak of the epidemic, and the medical system may face great pressure; the R & D speed of vaccines and effective therapies may be slower than expected; if the resumption of work is slow, small enterprises will go bankrupt on a large scale, millions of jobs will be lost permanently, and the economic recovery will be affected; political or financial considerations may be hindered Stop the Federal Reserve and / or the U.S. treasury from updating its monetary and financial instruments; even with the Federal Reserve and the U.S. treasury as the backing, there may still be a wave of default and bankruptcy; the business model of retail and tourism industry, office buildings and high-density urban centers may change permanently; the possibility of inflation or deflation, the loss of dollar reserve status, etc.
According to max, the positive and negative factors always coexist in the market, but at a specific point in time, the most important factor determining market behavior is which factor investors value more. What is clear is that after the March 23 low, investors are more focused on positive factors.
If there is a direct, reliable and generally accepted way to properly price a security, then (a) the security may be sold at or near that price, and (b) the market will not reach a too optimistic high and too pessimistic low. However, when things go well, optimism always accompanies, while optimism always strengthens and exaggerates the positive factors; when things dont go well, people will naturally feel depressed and exaggerate the negative factors. This ensures that the extreme high position and position of the market will always be the final result of the market cycle, not the exception. He added.
With regard to the recent roller coaster like trend of the stock market, Max quoted a sentence from his memorandum in January 2016 and commented: this is a strange thing. In the real world, things usually fluctuate between pretty good and not so good, but in the investment world, peoples opinions usually fluctuate between perfect and despair
The challenge is to figure out what is reasonable and what is abnormal. He added.
In summing up his views, Max chose to cite an idea he often mentioned that an experienced investor shared with him in the mid-1970s, namely three stages of bull market:
1. Only a few people with extraordinary insight can foresee the improvement of the market situation.
2. Most investors are aware that the market situation is improving.
3. Everyone thinks that everything will be better.
By contrast, the first phase began in mid March and reached its climax on 23 March. At that time, few people thought of the economy improving or the stock market rising. Then the market simply passed the second stage and directly entered the third stage. Clearly, when it hit its mid-term high on June 8, market valuations seemed to focus on the positive rather than the negative. Of course, its just my value judgment. I just think the focus of investors is out of balance, they focus too much on the positive and never question it, he added.
It is clear that Max is skeptical of the recent rally. In particular, he pointed out that many smart and experienced investors also believed that asset prices had exceeded fundamentals and issued a warning. For example, on May 12, as the S & P 500 index surged 28% from its March 23 low, Stan Druckenmiller, one of the greatest investors in history, said, the return on equity risk may be the worst Ive seen in my career. The next day, another great investment guru, David Tepper, said, this may be the second highest valuated stock market Ive ever seen. I have to say, second only to the 1999 valuation.
Max pointed out that there is no way to determine whether the rise is reasonable or unreasonable, or whether the market is too high or too low, time will tell us everything..
2. How likely are the positive factors driving the market to prove effective (or the influence of negative factors to increase)?
3. Is the positive factor fundamental (based on value) or mainly technical (i.e. related to capital inflow)? If its the latter, can their positive effects be temporary or permanent?
4. Is the market being boosted by strong optimism?
6. How does the valuation based on profit, revenue and asset value combine with historical standards?
I have come to the conclusion that the current strong rebound is based on optimism; the market only digests the positive factors and ignores the potential negative ones; the liquidity injection of the Federal Reserve and the stimulus policies of the Treasury Department have been the main driving factors, and investors believe that these stimulus measures will help the economy until the recovery really comes, and will not produce a high degree Negative secondary consequences. Mark said.
Finally, Max concluded: in other words, the fundamental outlook may be positive, but when the price of listed securities is at the current level, the board will face the disadvantage of investors.
Source: Financial Association editor in charge: Yang Bin_ NF4368