What's up Bubble #2?

Dear Reader,

The business cycle is very simple to understand. It goes from expansion to peak to recession to trough, and then it starts over again. Sometimes in more severe cases, it goes from expansion to peak to recession to depression to trough, and then it starts over again. In March when the stock market caught up with the health crisis but led the economic crisis, it corrected into a recession. Most people were predicting it would be a short-lived, “V-shaped” recovery. They were right. This correction allowed asset prices to adjust closer to their true valuations. Now what we are seeing is something even scarier. Irrational optimism, retail investors with their stimulus checks, and the Feds with unlimited QE have brought the stock market almost back to their initial highs. The graphics below show a couple of outstanding data sets. The first is how uncorrelated the stock market is to their 12-month estimated earnings per share (EPS). The second is how many retail investors have been active in the market recently. The third is how much the Fed’s balance sheet has grown since this has all started; over $7 trillion.

The risks I fear the most are: a wave of new confirmed virus cases, more speculation in vaccines and less successful trials, an increase in white-collar workers becoming unemployed (unemployment insurance can not cover their lifestyle expenses), and the credit market bursting due to more bankruptcies, more credit rating cuts, and negative interest rates. What will happen when the Central Bank tools run out or more importantly, what will happen when their practices and tools stop working the way they are supposed to? The year isn’t even halfway over, and most lagging economic data still needs to be released like GDP. Only time will tell, but this market is looking more like a bubble every single day.


The Market.

• Gambling for resurrection: if you’re behind in a game, big bold moves can make sense even if there’s only a small chance they will pay off.
  • What Trump is doing to try to win reelection. There is a good chance his bets will pay off.
• Developing countries owe about 30% of their GDP in debt services. They want relief on their payments until the end of the year.
• 12-month forward P/E ratio on the S&P 500 spiked to 31x and is expected to get larger.
• “A bear market once it’s underway will give you one opportunity to get out before the lights go out and the descent begins its earnest to the downside”
• “Elevated valuation pres­sures tend to be associated with excessive borrowing by businesses and households because both borrowers and lenders are more willing to accept higher degrees of risk and leverage when asset prices are appreciating rapidly. The associated debt and leverage, in turn, make the risk of outsized declines in asset prices more likely and more damaging. Similarly, the risk of a run on a financial institution and the consequent fire sales of assets are greatly amplified when significant leverage is involved.” – The US Federal Reserve
• “Asset prices remain vulnerable to significant declines should the pandemic worsen, the economic fallout proves more adverse, or financial system strains reemerge.” – The US Federal Reserve
• “The sheer scale of the current downturn and associated job losses, and the fact that some restrictions will need to stay in place until an effective treatment or vaccine are found, highlights how a full recovery is unlikely to be swift,” he said. “We anticipate that GDP will decline at an annualized rate of around 37% in the second quarter, and it will take the economy two years to regain the prepandemic peak.”
• Gold is an anti-monetary policy asset, meaning that it will climb as central banks carry on with printing more money to help kick-start economies around the world after extensive global shutdowns related to the coronavirus. 
  • “The Federal Reserve has been saying they will try all means to achieve recovery. We have seen from previous history episodes that all that means is printing as much cash as possible,” he said. “And gold is a natural tool against monetary policies implemented by central banks around the world.”
  • The number of Central Banks buying gold is expected to increase substantially this year.
    • 20% of Central Banks intend to increase their gold reserves over the next 12 months.

Uncertainty brings about confusion which brings about fear which brings about stagnation which causes missed opportunity. What we are thinking about now is what asset classes will be the most valuable in a couple of years and where will value come from? We are looking at REITs and other high-dividend paying stocks. With stock-buybacks decreasing and inflation being forecasted, your return will be dismal. Where will you get the extra percentage points to create Alpha?
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 Hindsight bias sucks because you can not use it, but great to learn from. From learning about how asset classes reacted to the current and past market conditions, I have learned many things:

Camden Alchanati:
- I would have shorted volatility when it spiked. 
- I would have bought into tech, e-commerce (Amazon, Shopify, MercadoLibre, Alibaba), and retailers selling essential items (Walmart, Target, Costco). 
- I would have bought more Gold. 
- I would have shorted restaurants and airlines. 
- I would have bought the March lows with more leverage than I did. 
- I would have sold out of my VIX positions at the highs in the 70s. (^VIX)
- I would have bought Bitcoin lows in the $4,000s.
- I would have bet against the biggest hit foreign economies (Brazil, Italy, China, India, Russia, and the U.K.). 

Alex Martino:
- I would’ve sold TVIX at a higher price above 700. I waited too long and got greedy, which I should not have done. I then would’ve bought back into the blue chip stocks, knowing that eventually the market would recover as it did 
- I would not have watched the market everyday, because the past few months have all been give and take. Trump says something positive and the market goes up, new data says something negative and goes it back down. Rinse and repeat.  

Matthew Campbell:
- I would have put more time into researching companies with strong financials to last or even thrive during a pandemic. 
- Sold out of more of my less risky assets and allocated more funds to speculative stocks. 
- Followed more pharmaceutical companies to capitalize on news of vaccines or new treatments. 


We have learned much more and moving forward we will use what we learned to make smarter, more profitable decisions. 

 
Keep Climbing,


The ACA Foundation