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What if the stock exchange is just right? Financial Advisor

(Excuse the radio silence here. It was a couple of crazy weeks between this brand new dad thing, the global pandemic, running a business, building my house and eating through the lock. Hopefully life is starting to normalize a bit and I can find more time to write!)

I always describe the stock market as a time puzzle. By that I mean that the stock market is essentially an eternal instrument whose future cash flows are unknown, so its price movements look like a series of random guesses about the future. Sometimes it makes optimistic guesses and sometimes it makes pessimistic guesswork. But on average, these prices come pretty close to “right”.

This is very different from an AAA 1% 1 year CD, an instrument whose income and time horizons are almost certain, so you won’t get any crazy major changes over time. I have always said that I like to see the stock market as a 30 year high yield coupon with a coupon of 6-7%. You can be pretty sure what the instrument will pay off over several decades, but good luck guessing what it will do on a particular day, month, or year, as no one knows how that 6-7% will pay off over time .

Even more importantly, this “riddle” is sometimes exacerbated when the stock market subsides and flows when it looks too optimistic or pessimistic about the future. For example, in 1999 you could argue that the stock market was too optimistic about the short-term effects of the Internet. As a result, future prices were raised significantly in an unsustainable manner, resulting in a bubble that detached itself from the short-term reality. Or in 2009, prices collapse when investors begin to evaluate a 1929-style economic result, and future prices are pulled into the present and eventually recovering as this unsustainable negative expectation does not materialize.

That brings me to the current environment. One that people seem to think is being manipulated by the Fed or detached from economic reality. Yes I understand. And I agree something Degree. The stock market doesn’t look particularly attractive in many ways. But what if the stock exchange is exactly right, what’s going on? What if it pulls this temporal riddle into the future like sometimes? Let me elaborate on this.

So we got into the year and expected more of the same – good but stable growth. Then the COVID meteor hits. The prices are falling. The conversation about the global economic crisis was widespread. The stock market is experiencing the fastest downturn ever. Then things start to improve. China’s COVID cases are disappearing. Italy’s cases slow down massively. The cases in the US have peaked. The government shoots a huge bazooka at the economy. And suddenly the Great Depression 2.0 scenario looks pretty wrong. Stabilize prices. Then start climbing. And the prices just keep going up. And up. And up. And here we are.

But keep this in mind. What if the restoration is basically priced in? What if we had our V-shaped stock market recovery that would pull prices more or less flat into the present and now into the future (see Figure 1)? What if, unlike a 2009 style Swoosh market recovery, we would only achieve that recovery much faster? This is exactly what happened in 1919 during the Spanish flu. Stock markets plummeted 25%, then recovered quickly and were dead money for a few years before the Roaring 20 really got going.

Could the same thing happen here? I think so. And if I’m right, two things can be true:

  1. The stock market and the bulls were just right. The recovery is coming and the stock market is already seeing it.
  2. AND the stock bears are right that the stock market looks like a fairly unattractive asset class right now, as it has priced in expected cash flows for many years.

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