The relatively high level of U.S. stock prices in the face of so many crises continues to perplex many people. It raises questions about what drives investor behavior. Will investors react to another wave of the global pandemic that is wreaking havoc on the most vulnerable communities and small service businesses? Will the appetite for stocks diminish as investors ponder the tensions stemming from racial injustice, the environmental impacts of climate change, the rise of right-wing militias, a potentially contested election, increased polarization of the citizenry, and threats to democracy and the rule of law? The answer, for much of the summer and fall, has been “no”—investors appear undeterred. Investors remain sanguine because they expect the government to more than cover any economic losses brought on by fire, flood, or Covid-19. So far, this confidence has been well-founded. Combined, the Federal Government and Federal Reserve have poured trillions of dollars into the economy, kept interest rates historically low with a promise to do so for years to come, and elevated both housing prices and stock prices in the process.
Before diving into the recent political news cycle, it is important to note that financial markets are typically apolitical over the long arc of U.S. history, with no strong correlation in market returns to either the makeup of Congress or the political party of the President. Most of the time investors are happy with a stable, even gridlocked, political situation, one that leaves most economic decisions to business owners and the millions of consumers they serve. The situation is quite different when the economy is in crisis, as it was during the Great Depression, the Financial Crisis of 2007-2008, and now with the Covid-19 pandemic. In times of crisis, investors want a unified central government that will quickly pass as much relief as necessary to bail out companies and stimulate consumer spending. The prospect of unified government action diminished in September as the Presidential polls narrowed and talk of a contested election increased. Fearing delayed stimulus at best, and real threats to our democratic process at worst, the stock market quickly gave up all its gains on the year in a few weeks. The market has since rebounded in October, likely as the odds of a Democratic Party sweep and a certain path to more stimulus have strengthened.
More economic relief is needed now, but it must be stressed that stimulus of this size and with this urgency is never ideal legislation. Just as in 2008, when it was critical to flood the financial sector with liquidity and speed through a trillion-dollar rescue package, the government has summoned even larger sums to stave off economic collapse during the pandemic. Increasingly it seems that the only moments of meaningful legislative action come during bouts of intense crisis that demand an overreaction, because to risk an underreaction would be too dangerous economically. As a result of this process, our country’s debt to GDP has more than doubled over the last twelve years, reaching a level only seen in the aftermath of World War II.
A failure of government policy, like we have seen this year with the uncoordinated, confused response to Covid-19, comes with some cost. The human toll is evident during this pandemic, while the immediate economic toll is felt by the unemployed and the many small businesses that have folded this year. But there is a longer-term economic cost as well. As our government spends massive sums today to rescue the economy, its ability to spend tomorrow on potentially meaningful discretionary legislation is inevitably curtailed. Instead, a greater share of future tax revenue must be earmarked for interest payments to service our growing national debt.
The structure of the economy has changed remarkably in a matter of months, as we all readjust how we live and work. As we mentioned in our last Update, this has benefitted technology companies greatly, while other industries teeter on the edge of bankruptcy. The shift has been a boon to the major market indices. These indices, including the Standard & Poors 500, were heavily weighted toward the technology sector before the pandemic, and are now thoroughly dominated by the massive technology companies that serve billions of people around the world. For the moment, investors should think of the U.S. stock market as less representative of the total domestic economy and more a reflection of the fortunes of the global technology industry. Amidst the chaos of Covid-19, the latter obviously paints a far brighter picture, and is one reason why the stock market has risen in a time of such turmoil and hardship. This changing makeup within the indices, coupled with the massive amounts of stimulus, have allowed many investors to skate through an otherwise treacherous economic landscape.
We too have steered away from an investment portfolio that matches the broader domestic economy. This year we have invested primarily in technology companies, medical technology manufacturers, and consumer staples brands. These investments have performed well as collective economic behavior and spending patterns change in response to the pandemic. But the strength in shares of technology companies relative to the weakness of nearly everything else is becoming stretched. When the economy begins to return to normal, there will almost certainly be a significant reshuffling of relative value in the stock market. “Normal” still feels far away for most people, but as investors we look several years into the future and we are beginning to craft compelling narratives for some companies that work outside the favored industries highlighted above. In many cases, this narrative hinges on interest rates remaining at ultra-low levels, but with the Federal Reserve promising to keep rates fixed through 2023, this seems an increasingly sure bet.