Stock Talk School: Waiting No More — This is How Early Bull Markets Look

Join Chris Perras for the 10/30/2020 edition of Stock Talk!

Chris Perras: Good morning. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group here in Houston, Texas and welcome to our weekly Stock Talk Podcast. This is October 30th, and this is Keeping You Connected to Your Money. This is the last week in an ongoing multi-week series entitled, Waiting. We started this series way back in late August, with the stock market’s moving parabolically upward toward almost 3,600 on the S&P 500. That segment was entitled, Curb Your Enthusiasm – Election Volatility Breeds Investment Opportunity. Today, I give you the final chapter in the series. It’s entitled. Wait No More, This is How Early Bull Markets and Stocks in the Economy Look.

Since late March, the investment team has been discussing almost weekly with clients and listeners that we saw a strong likelihood of a V-bottom in both stocks and the economy most likely for mid-2020. Since mid-August, for the past three months, we have tried to educate our clients and listeners as to the normalcy of pre-presidential election volatility. This focus appears well justified as the markets have now pulled back to basically flat year-to-date with a big jump in volatility the past two weeks.

For the past four weeks, we have stressed that this increase in short-term volatility is what actually breeds higher investment returns and higher opportunities if one can control one’s emotions and biases. That the period of higher implied volatility is what long-term investors should be looking for and when they should be pushing their chips and their dollars into the market, not abstaining or fleeing the markets. Well, listeners, we are finally here. It’s time.

The next few weeks should continue to stay volatile in the short term. Why? I don’t know. I can make up reasons like everyone else. Factually, I think due to states’ individual voting procedures, we are unlikely to get an official winner in the election next Tuesday night due to the massive early and mail-in voting that has occurred. The experts in voting say that it should take into the weekend to count the totals. Maybe it’s contested. We’ve covered contested elections and what they’ve done historically.

On this topic, I am a conspiracy theorist in that I do think someone might know relatively quickly, maybe even this weekend, the most likely outcome of the election even if the election count is delayed a few days. The markets have pulled back to 3,275 on the S&P 500. This is almost exactly where we stood at the end of July, three months ago. The convenient excuses being thrown around the past two weeks on TV are a sudden increase in COVID cases in Europe and in the US, which has probably been going on now for four weeks and probably is scaring some investors short term.

Number two, the presidential election jitters and vote-counting delays. We’ve covered this topic numerous times the past six months in advance of the election. Three, a lack of fiscal stimulus agreement by the politicians in Washington, D.C. until after the election. Four, and this is my favorite one, in two short weeks, the press has gone from parroting that a Democratic blue wave and the election was good for markets to when the market’s 300 points lower on the S&P, now a blue wave in the upcoming election would be bad for markets. I find this flip-flopping in opinion and excuses hilarious.

In a span of four weeks, a blue wave went from negative to positive to negative event for the markets. These fuzzy reasons are exactly why I like to stick as much as I can to fact, data, and history as investors tend to replicate the same behaviors cycle after cycle. The outcome of the 2020 election should have very little negative weight on the markets after mid-November as far as time and price is concerned in overall stocks from 3,275, the risk-reward over the next 15 months as I calculate it, happens to be at almost 10 to one upside to downside.

How do I arrive at that? There appears to be about 3% to 4% downside, down to the 200-day moving average of about 3,150 on the S&P 500, and about 30% to 40% upside and an optimistic outcome of the three major issues of concern in the stock market being alleviated over the next 3 to 12 months. As a whole, stock returns look to accelerate upward along with the real economy the next five quarters.

First is the idea of a reacceleration in real growth, not just inflationary growth post-election through 2021, much akin to the reacceleration in real growth in the economy that took place post both the 2012 and 2016 elections, won one by a Democrat, and one won by a Republican. Listeners, reacceleration in real growth are massively bullish for the overall stock market as more groups besides FAANG work, the market broadens out. You hear the term breadth expansion more often. In layman’s terms, more people get invited to the party, more groups work in the stock market, and more individual companies outperform the overall averages.

Besides in broad market downturns, it’s when being more diversified really pays off. A little academic lesson in Treasury bonds and their yields and interest rates they pay you. You can dissect the bond yield of a Treasury into two components. One is inflationary growth, and one is real growth. The sum of those two is the overall yield in the Treasury bond that you are looking at.

What you will find is that currently, real growth as determined by the Treasury market is extremely low. However, it is troughing and starting to turn up slowly. This happened in the same manner in the fourth quarter of 2012 in front of the election, which a Democratic won. It also happened in the fourth quarter of 2016 in front of that presidential election, which President Trump won. In both cases, within weeks of the election results, the real economy as seen in the real growth component of Treasury markets started accelerating up materially.

Likewise one can see by the chart on the S&P 500, it too started to rise almost precisely when this measure of real growth did, subsequently, the stock markets rose almost exactly 38% from their election lows under both of these presidents the next 15 months. It is interesting to note I think that the biggest post-election rally over the next 15 months actually occurred in 1932 when the sitting president lost his reelection bid and Congress flipped entirely to the presidential elect party.

Way back then, yes, that was way back when the liberal Democrat FDR was first elected, the markets initially fell about 4.4% into year-end, and then they gained an impressive 44.1% the next year as the stimulus of the new deal was rolled out. What’s particularly interesting to me is that the total return over that 15-month period post-election lows, fourth quarter, 1932 through first quarter, 1934, yes, you guessed it, up almost exactly 38% low to high.

Why did the economy and markets behave and work so similarly under totally different presidents with totally different philosophies? I have one word for you, stimulus and its lag effect. Back on September 14th in 2012, the Federal Reserve announced Q3. They waited about two months before actually starting to buy bonds aggressively, and they executed that program throughout 2013. The real economy accelerated with its normal lag, volatility declined dramatically with its normal lag, and stocks marched almost linearly upward for 15 months by about 38% through early 2014.

Fast forward to 2016 in President Trump’s win, this time around the stimulus was not the federal reserve and its tailwind, it was the anticipation of President Trump’s tax cut. Listeners, there’s one keyword in that sentence. What’s that word? That word is anticipation. Here’s what happened. President Trump was elected and for 15 months, there was a single focus by the administration and the stock markets on one thing, what was that one thing? It was a tax cut.

The stock markets troughed Friday, election week, and then what happened? Yes, real economic growth troughed and accelerated in fourth quarter, 2016 through early 2018 and both real growth and the stock markets did what? They troughed. Volatility peaked and proceeded to collapse through 2017. Listeners, remember way back then to those good old days of calm? To no COVID the virus counts? Remember back to the good old days when stock markets never seemed to go down? Of [unintelligible 00:09:16] constant underlying bid to the stock markets? Of volatility so low it looked like fake data or fake news? Remember those days?

Well, that’s what a stimulative market and consistent policies can look like. Nothing like the good old days of consistency, boring, and profitability. The stock markets went up almost exactly 38% from their election bottom in November 2016, through early 2018 in anticipation of the tax cut. The markets actually peaked when the tax cut was passed in early 2018, and it went nowhere again until late September 2019.

Listeners, please do not let your election become an emotional event or crusade that drives your short-term financial behavior. It is another event whose outcome we can’t control. Fight that feeling to change everything based on next week’s election outcome. Why? Because 2021, regardless of who wins next week, is loaded to the gills with that keyword I used to describe post-2012 and post-2016 election economic environments. What’s that word? That word is stimulus. We already know the Federal Reserve’s plan for monetary stimulus in 2021 and 2022, and they haven’t even started implementing it yet.

We’re calling that QE5. Much like 2012 when they paused before implementing QE3, the Fed is waiting until the election is passed. Then the positive wild card stimulus for 2021 is the fiscal stimulus package that either elected party that the TV pundits have so quickly given up on the last 10 days as the stock markets have fallen, passes. Somewhat offsetting these two stimulative actions would be an increase in corporate tax rates and personal tax rates.

Given the current focus on high unemployment rates caused by COVID and the fragility of parts of the traditional economy, I believe there’s a likelihood that many of these increases in taxes are deferred into 2022, leaving mostly beneficial stimulus to the markets in 2021. Lost in the normal pre-election noise is the bull case for 2021 in that the 2020 President, whomever that is, and Congress, whomever that is, put job growth in the economy first through additional spending or incentives. This is in addition to the Federal Reserve’s monetary expansion.

We personally may not like how much of our money the politicians spend or what they spend it on, but regardless of who is elected, they will spend lots of our money, probably trillions in our money in 2021. I will continue to argue until proven otherwise, that this fiscal stimulus in the trillions of dollars will be wildly positive for economic growth in the stock markets in 2021. This stimulus is an addition to the Federal Reserve’s 1.8 trillion in additional monetary stimulus it has on store and planned for the next 15 months.

Throughout all financial markets, bond markets, stock markets, and commodity markets, we’ve seen this movie and story before. What transpired in front of the Democratic presidential win in 2012 and in front of the Trump win in 2016 is happening again behind the scenes. The political party didn’t matter. Bull markets can begin with a blue or a red flag. Each election period since the great financial crisis in 2008/2009 have showed similar patterns in stocks into and out of each election and the markets and economy showed similar responses post-election.

By the second half of 2021 when we have a vaccine for the virus or a fiscal stimulus plan that has been formalized and written in stone, the TV pundits will likely declare, “The coast is clear.” Unfortunately, by then, the markets will likely already be materially new, all-time highs trending higher, with the TV pundits declaring that the easy money has been made. Listeners, there is no easy money in the stock market. There is no easy money in life unless you win the lottery or inherit wealth. In the stock markets time and time again, we are reminded by history, that easy money is made when others are scared or paralyzed and volatility is high.

It’s always easy in the rearview mirror. Don’t let politics cloud your investment judgment. Stay the course or take advantage of others’ emotions and as Warren Buffett says, be greedy when others are fearful. This is how early bull markets look. They always look and feel unstable at first because they are trying to grab a foothold and they’re torn between the selling of investors who wave the white flag and say I’ve had enough of this, I’m leaving the party after an appetizer in the warm-up band, and those investors who think longer-term and who are incremental buyers who say I’ve weathered the hard part, I’m going to hang around for the main event and for dessert. I ask you listeners, who doesn’t like dessert?

At Oak Harvest, we’re a comprehensive long-term financial planner. What this means is that as our client, you and your financial advisors should have a financial plan that is independent of the volatility of the stock markets. If you’re retired or in the process of retiring, give us a call at 281-822-1350. We are here to help you plan your financial future and help smooth the financial path you have into and through your retirement years through a customized retirement planning. Many blessings. This is Chris Perras, Oak Harvest. Stay safe, be well.

Speaker 2: The preceding content 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, statistics, and sources are not guaranteed. Content, ideas, and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Investing involves the risk of loss and past performance does not guarantee future results