Nolte Notes 8.10.2020

Nolte Notes 8.10.2020


The much-anticipated employment report was released with a range of estimates large enough to drive a few trucks through. The weekly jobless claims released the day before was at a new low for this cycle, but still 50% higher than at the depths of the great recession. So, investors were nervous ahead of the release. The numbers were much better than expected, with the unemployment rate falling to just over 10%. Combined with the much better than expected manufacturing and service reports earlier in the week, it set a good overall tone for the market. For all the good news, there is a dark side. The wrangling in Washington for the next round of stimulus payments could get watered down with better overall economic data. The President used executive orders over the weekend to extend benefits and set the table for further gains. However, if the economy can heal relatively quickly, it means less of a need for government assistance that could wind up in the financial markets. At this point, good news remains good news and the markets are reacting accordingly.

The equity markets are once again within hailing distance of all-time highs, even as earnings continue to decline (estimated to bottom this quarter) and the economic data, although better, remains well below even the depths of the last recession. As stocks continue to rise as earnings decline, the valuations of the markets are once again heading toward historically high levels that essentially squeeze out future returns. Why are stocks still rising if the economy remains a long way from healthy? The data points are getting better, but the key has been the very low interest rates. The Fed has promised to keep rates at current levels for the foreseeable future and will allow inflation to run above 2% if it ever gets there. Earnings have been coming in above extremely low expectations with some companies beginning to provide estimates. All has been providing fuel for the continued stock rally. At some point earnings growth, rather than less bad, will have to carry the day.

As mentioned above, interest rates continue to be the key to higher stock prices. The Fed has been very active in the financial markets helping to maintain liquidity as well as keeping interest rates low. Over the past three recessions, the Fed involvement has ramped up. In 2000, the Fed cut rates aggressively to 1%. After the financial crises, they introduced zero interest rates and quantitative easing. This time, zero rates, QE and buying of corporate securities. Each time they have amped up their involvement, not always to provide trading liquidity, but to keep the financial markets propped up to provide the appearance of normalcy. As a result, the financial markets have not been standing on their own for quite some time. What will happen when the Fed pulls back from supporting the financial markets?

Earnings season is winding down this week, but the excitement about technology stocks and their potential growth over the coming years, due in large part to the virus hastening the use of technology. The markets began to rotate away from technology on Friday as signs of “better than expected” economic data is leading investors to begin looking at the more “cyclical” parts of the markets, including transportation, retail, and industrial companies. We have seen this movie before in late May, when value took the performance lead from growth only to give it up in mid-June. If the markets are going to make further headway, it will have to come from the other 70% of the market that is not technology related. During this time, the lower dollar is also making international investing “cool” again. It has also helped that the virus growth has moderated in many European and Asian countries that has allowed them to begin turning on the economic spigots.

A shift toward more value names and away from technology, rather than the end of the bull market, may be what the markets need to move into new all-time high territory. Bullishness should be moderated, though, as valuations are also near all-time highs, which should tamp down future returns from here.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.