Instances That Will End This Stock Market's Exuberance
In a year of geopolitical issues, a virus, protests, fires, and elections, only one member of the community has come out winning: the stock market.
With investor confidence as strong as ever going into 2021, the only question seeping through our minds is twofold:
When does this end, and given that, how can we prepare?
Against the backdrop of such quandaries, here are some events that could break our bull run going into the new year followed by suggestions on how you can protect yourself going forward.
Each week produces a new win in the vaccine department. Pfizer, Moderna, Sinopharm: a trifecta of successful stories soon to be joined by AstraZeneca-Oxford after some momentary dalliances have been wallowed out. With so much positivity now priced into stock markets - in other words, stock prices have fully taken into account the benefits of vaccine developments - what happens if that narrative is suddenly swayed?
“Any delay in implementation or resistance towards mass vaccinations early next year will hamper a smooth reopening of economies, potentially chipping away at upbeat growth and corporate profit estimates.” – Michael Mackenzie, The Long View
This is particularly important given the relative nature of markets. In other words, the current narrative is that we are all on the brink of protection against COVID-19, which means that anything that shifts this story aside (distribution/reaction/acceptance issues) is likely to unease investors: causing a market meltdown going forward.
Fuel from the Fed
A large part of this market’s euphoria comes from the Federal Reserve’s host of trillion-dollar promises. Whether it’s helping Main Street businesses with billions in lending programs or buying bonds from the runt of the litter - I.e. “junk” rated companies that are unlikely to ever pay back their debts - investors have been conditioned to believe that the Fed will be there to catch us whenever we fall.
Figure 1: The market's storyline this year.
But how much longer can they extend their support going into 2021?
“To support the flow of credit to households and businesses, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning” - FOMC
According to the meeting notes from the Federal Open Market Committee above, the central bank has no intentions of cutting or even slowing down their pace of buying corporate bonds. We think the result of this consistent conditioning, as esteemed psychologist Robert B. Cialdini alludes to in his book, “Influence”, is a “Click, whirr” response in investors. In other words, an automatic, machine-like reaction of buying even more stocks, because the market now immediately associates more Fed support with more bullish upside.
Thus, because the Federal Reserve has won the eyes, ears, and hearts of investors so strongly this year, any change in their friendly tone would be another way to potentially halt this market’s exuberance.
What can young investors do to prepare?
Laying out our cards on the table, we’ve got an extremely expensive and frothy market that A) has priced in a smooth vaccination process and B) continues to rise beyond levels last seen in the hype-era of 2000. In other words, uncertainty, and because of that we maintain our threefold solution:
Cash, cash, cash: Given the upheaval markets have recently seen – a byproduct of a Biden win plus positive vaccine news – it’s likely too late to be piling into stocks now. The main indexes have all hit record (or near-record) highs, which means that young investors would be better off keeping some cash aside and waiting for the next mini correction. If you’re looking to make investments, you’d most likely benefit from buying undervalued bank names (longer-term), buying the dip on big tech names, and using the quick index strategy in the video below.
Gold: Alongside keeping cash aside, beginners can use a small proportion of their overall capital to nibble on gold. The long-term drivers of bullion are still positive, suggesting that the recent price drops may be a lucrative buying opportunity for those investors who are comfortable with some volatility. However, low leverage is recommended because of regular swings in gold prices.
You wouldn’t be alone in thinking that the numbers in this market are too high and that we’re shortly due for a correction, but 2020 has shown that solely using this mindset is a mistake. As the master of money managers Peter Lynch says:
“If the things that attracted you to a stock/company/market in the first place are still there, don’t sell.”
The things that fueled this market, the Federal Reserve and the vaccine, don’t seem to be going anywhere, which is why our sentiment is still positive for stocks going forward. Even with small pullbacks every now and again (because of profit-taking), the suggestions above will allow you to buy the drops whilst simultaneously keeping a close eye on the two factors above, as the developments there will be the biggest drivers of this market’s direction.