Busting the Myths of “Unprecedented Times”

Stock Talk School:  Busting myths. Chris Perras for this April 2, 2021, edition of Stock Talk!

Chris: Hey, good afternoon. I am Chris Perras, chief investment officer at Oak Harvest Financial Group here in Houston, Texas. Welcome to our April 2nd weekly Stock Talk podcast: Keeping You Connected to Your Money. Well, the S&P 500 continues to reaccelerate to more new all-time highs, much to the dismay of dune state predictors, interest rate naysayers, and inflation warriors. This week’s podcast title is Unprecedented Times Myth Busters.

I’m going to cover a few of the myths that many financial news channels keep promoting to catch viewers’ attention, but they only serve as disinformation, and they serve to drive many investors to continue to stay out of the markets even during the ongoing bull market. Myth number one, we are in unprecedented times for stocks. This statement of unprecedented times and stocks is categorically false. The markets represented by the S&P 500 have mirrored most of the same recoveries the markets have had since 2008, 2009.

Now, yes, this is largely due to federal reserve monetary action, but listeners, it counts. These aren’t false profits as in gains as many of the false prophets as in soothsayers writing financial newsletters would want you to believe. The federal reserve policy response due to the COVID virus outbreak was magnitudes larger than previous responses this cycle, but it should have been, given to this was an event-driven recession, and we literally shut down the country for three to five months.

Now, myth number two, markets would tank 20% to 30% if Joe Biden won the presidency or the Democrats had a blue wave in Congress because that would move our country more towards socialism. Well, obviously that didn’t happen, just as it didn’t happen when liberal democratic Barack Obama was elected in 2008, and then re-elected again in 2012. The S&P 500 is up about 20% from the start of November when president Biden was elected. With about 7.5% of that total return coming post, the Democrats winning the Georgia state Senate races.

We compare this myth with the one that stocks like conservative Republican policies better than liberal Democrat ones. The S&P 500 turn from election day in November of 2012, when president Obama was reelected, through the first quarter of 2014. That returned was almost identical to the stock returns from when president Trump was elected in November of 2016 through the first quarter of 2018. The stock market returned under both of those presidents almost an identical 38% under diametrically opposed presidential policies.

Myth number three, higher long-term interest rates are hurting stocks. Now, listeners, yes, higher trending long-term interest rates are suppressing high growth valuation metrics and capping the FAANG universe broadly. However, throughout the entire 2009 through current recovery, higher trending long-term interest rates, which lead to a steepening in the yield curve have been wildly positive, not negative to the overall stock market.

In fact, one can see if one overlays long-term interest rates in the S&P 500 that all the material new all time highs that were sustained for months and quarters since 2009 have come as the overall long-term interest rate was rising, not falling. Why? Because that higher trending long-term interest rate is an indicator that either or both inflation and real growth are accelerating, not peaking and slowing, that the economy was improving, not getting worse.

More groups in the market work during these periods. Market breadth expands, not contracts. Big investors do not feel compelled to hide in a few number of large stable or fast-growing behemoths like the FAANG complex. We covered this breadth thrust pivot way back in October of last year, pre-presidential election when we were focused on a very rare Marty’s wide breadth thrust reading. Few people on CNBC still have even discussed this, negative and fear-based topics always sound smarter and are always more engaging to listeners.

Myth number four, inflation is accelerating, and it’s going to get worse throughout 2021. Well, yes, inflation has accelerated the last 12 months. Listeners, that’s what happens when you shut down an economy, constrain the supply, and hound out trillions of dollars to workers and non-working Americans to try to make consumers whole and to have them spend the money. However, just as commodity, such as lumber, copper, scrap steel, and wheat, and five-year real-time inflation breakevens turned up in late March of 2020.

Well, now, they’re showing signs of peaking the last two to four weeks. The year-over-year rate of change in these is peaking, it’s not accelerating. The most interesting ones to me are scrap steel, which is used as a primary input to steel mini-mills. Well, that commodity peaked weeks ago just as reported imports of foreign steel and domestic capacity restarts and expansions are hitting the supply side for the second and third quarter.

Here’s a direct quote from some sell side research that we use a steel analyst. What he said, steel prices have reached new all-time highs over the last two weeks, but looking ahead, domestic production and imports are accelerating while raw material prices are trending lower, suggesting the ongoing supply squeeze should be peaking and the easing over the coming months. Listeners, if automakers are curtailing production over semiconductor shortages, do they really need more steel sitting idle in inventory? Probably not, but that’s forward-looking. That’s not trend following, which so many investors want to do nowadays.

Listeners, I’m going to give you a more personal analogy. Take those wonderful $3000 to $4,000 Peloton bikes and treadmills that everyone wanted last year during the COVID lockdowns. I hear it’s a great product for my friends who own them, they love them, but remember way back in the fourth quarter of last year, a mere four or five months ago, when everyone wanted one of those Pelotons, and the lead times were six to eight weeks, maybe more, and that company couldn’t guarantee delivery by Christmas because they’re made overseas and demand was so great. They were backlog and they’re having to expedite orders on ships.

Well, guess when the stock Peloton peaked for the overall stock market? The ticker on Peloton is PTON, and go pull it up on a chart. Well, if you guessed it peaked on December 24th, relative to the S&P 500, on Christmas Eve, you would have been spot on. That’s exactly when demand was off the charts good when orders were flowing over the phone lines and the internet for their products, and the stock, what did it do amongst a massive positive order environment for the products? Well, it dropped 45% peak to trough in just over two months.

Listeners, in a global world with competition everywhere, supply and demand will eventually equalize. It may take months. It might take a few quarters, but when it comes to commodity markets, remember, markets are always forward-looking at least by two to three three months, they will equalize. Yes, I believe inflation will be picking up over the next 3, 5, and 10 years, but it will not be because of COVID. It will be because millennials and Gen Z-ers for such a large population cohort, are likely to push up the price and the cost of whatever they consume. Just as the baby boom generation drove up varying assets as they went through their family formation and consumption years, the millennials and Gen Z will do the same.

Myth number five, this one is one of my favorite myths because so many people talk about it on TV, like they’re experts, but so few people understand it. What is this final myth? This myth is the myth of volatility, that it’s high and even extreme today, and it will stay that way. This is 100% garbage talk and has been since at least November of last year post-election. Most people on TV quote the VIX spot index as their measure of stock market volatility or uncertainty. Some people go as far as to call it the fear index. Listeners, this is a misnomer.

The spot VIX index is purely a math calculation built by the Chicago Board of Options Exchange based on a basket of S&P 500 options that expire over the next 30 calendar days. It’s just math. The main VIX index calculates 30 calendar days of implied volatility in real-time. It’s just a mathematical calculation based on implied volatility, somewhere in the future. However, and this is where it gets interesting and the valuable information lies. You can trade options and futures contracts on the future VIX level. The punchline to this statement, mathematically, overall stock returns have been observed to be negatively correlated with actualized realized volatility and positively correlated with implied volatility levels and direction. I repeat stock market returns have been shown to be positively correlated with implied volatility levels and direction. With the term structure of implied volatility free and readily available on the CBOE website, an investor might want to follow the future structure of volatility months out into the future. For this specific observation, I’ve taken the three-month forward volatility contract, which right now, would be for mid-June expiration. Now, listeners, I know you can’t see the chart, but trust me when I say, there is nothing in this chart since April of 2020 that says the three-month forward volatility is rising.

Yes, there are some sell-offs in the chart in volatility, four to be exact, but the overall trend for almost 12 months since April of 2020 at the height of COVID is down. It is a trend that shows a series of lower highs and lower lows. In April of 2020, forward volatility for 3 months stood at 40. Today it sits at about 23 1/2. Listeners, what do momentum investors say? They say, “The trend is your friend until it isn’t.” Lower trending implied volatility is great for stock prices.

The next time some supposed market expert or hedge fund manager on TV talks about volatility being so high or remaining so, ask yourself, “What are they talking about?” If they mentioned the subject of volatility, is it realized volatility that they’re talking about? Realized volatility is highly random volatility that you see on your screen day-to-day. Is it implied volatility that actually does have some predictive power in defining overall stock market direction over time?

When you have some time, in your spare time, go check out the CBOE website. Pull up some real-time quotes and charts of future volatility, and then make up your own mind. As for the markets, the investment unit at Oak Harvest is already looking out to better position portfolios for the second half of 2021. We’re looking for companies and investors should be looking at with a glass-half-full attitude come the back half of the year and in 2022.

Between, say, July 4th and Labor Day, investors will once again be looking forward. They’ll be looking out to the second half of this year and all of 2022. What do you think they’re going to see? Well, they will see that higher secular growth companies that peaked way back in the third quarter of 2020, and if stalled through here, well, they’ll see that their valuations have compressed now for three or four quarters, and now they’re cheap for their long-term growth and free cash flow profiles.

Big investors who have been chasing and pushing up value stocks since last year in the third quarter will start asking themselves, “Am I paying peak multiples for peak EPS in 2022 in these names 6 to 12 months in advance?” At Oak Harvest, we are comprehensive long-term financial planners. What this means is that as our client, you and your financial advisors should have a financial plan that is independent of short-term volatility in the stock markets. Give us a call at 281-822-1350. We are here to help you on your financial journey through retirement with a customized retirement planning. Many blessings. Stay safe. God Bless America, you and your families. Have a great Easter weekend.

Speaker 2: All content contained within the Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice. Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax, or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment, and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss, and past performance is not indicative of future results.