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How can the markets go up when the news is so bad?

| April 15, 2020

“A Path Forward”    

How can the markets go up when the news is so bad?                                                                                                            4/15/2020    

Last week the stock markets rallied 12%, measured by the S&P 500, in a week when 6.6 million people filed for unemployment, the death toll from the COVID-19 outbreak was hitting daily highs, the total infection numbers hit 2.0 million and 46 of 50 states were under “lockdown”.

Many analysts think unemployment numbers are understated and that the real numbers would be much higher if states’ online and phone systems weren’t overwhelmed. The jobless rate is 10% and may hit 20% or more this year. The US economy is in recession. The second quarter GDP numbers may be the worst recorded since we started measuring national output in 1934.

So how is it possible that markets could have their best week in 45 years when the news seems so bleak? What am I missing here?

There isn’t one answer that encompasses everything that drives markets. It’s impossible to know every piece of information that millions of investors use to decide whether to buy or sell stocks and bonds. But here are some factors that do drive markets:

Stock markets are forward looking: Investors look years into the future when they decide how much a stock is worth. The stream of earnings from a company over many years is much more important than what happens in the next 3 quarters of 2020. Investors know that this year’s profits (or losses) are going to be bad, but what happens in 2021 and 5, 10 or 15 years beyond that is what makes owning a piece of company worthwhile. Company profits will recover and eventually markets build that into prices.

Markets are anticipating the worst of the virus outbreak is near: Markets gained dramatically on last Monday on news that New York state saw the peak of deaths from the virus coming shortly. Yes, that sounds terribly morbid and stomach turning. But see above; markets look to the future. Less bad news,“curve flattening” for instance, is often treated as good news.

Dramatic government action: There is not enough space here to list all the government and Federal Reserve bank programs created in the last few weeks. And I can’t keep the acronyms straight in any case. The government is acting quickly to try and offset the economic damage and the markets are responding positively. Whether it is enough is anyone’s guess but bold action by the Fed to keep companies from going out of business while they are shut down is better than no action.

Stock prices are much more attractive than a month and half ago: Stock prices are often measured in price to earnings ratios. Before the drop in prices earlier this year, the price to earnings ratio was over 20. Today it is around 15 (based on 2021 estimates). This makes stocks more attractive to investors, especially with interest rates around 0.7% on a 10 year US treasury bond or less than that on a money market account. Stocks prices tend to be higher when interest rates are low, and rates are very, very low right now and not likely to go up any time soon.

Much of the bad news is already “priced in”: We all remember how quickly the stock markets dropped in March. Those declines were likely investors “pricing in” how badly the virus outbreak would affect the US economy. At some point investors decide that prices are low enough once the news and the responses of the government and Fed are factored in.

Bear market rally?: Some of the strongest and largest rallies in stock prices happen during bear markets. Several rallies of over 10% happened during the 2008-2009 bear market. Is this just a bear market rally and the markets will drop further? I don’t pretend to know the answer. But if you’re a long term investor, it shouldn’t matter. Your goals are well beyond the end of this quarter or end of this year.

What we can we take away from all this?

Trying to pinpoint when to buy and sell stocks is next to impossible.

Markets will move in unpredictable ways, both up and down, as we work through this crisis.

Staying invested, even in turbulent, bumpy markets gives you the best chance of long term success as an investor.

Patience, especially in a market behaving like this one, is absolutely critical.

Warren Buffett is quoted as saying: “The stock market serves as a relocation center in which money is moved from the active to the patient.” Maybe this sounds trite in a time like this but it couldn’t be more true.

Stay healthy, stay safe and stay positive!