Legendary investor, Benjamin Graham, explained the stock market in the following way: “In the short run, the market is a voting machine, but in the long run, it’s a weighing machine." What he meant was short term stocks are greatly influenced by news, trends, and the emotions of investors (fear or optimism). But in the long term, stock prices are determined by future expected earnings. Since the emergence of COVID-19, the stock market has been acting more as a voting machine and less as a weighing machine. Swinging down in March on fear and rallying so far in April on optimism that the curve is starting to flatten. The market upswing continued this week and we have made back almost all that was lost in March. Friday's move higher was based in large part to a news report that patients who are getting an experimental drug (remdesivir) have been recovering quickly, with most going home in days, The patients taking part in a clinical trial of the drug have all had severe respiratory symptoms and fever, but were able to leave the hospital after less than a week of treatment, News that we may have an effective therapeutic is encouraging because it could potentialyl push forward the time table for getting life back to normal. For those in at risk groups life won't likely normalize until we have a vaccine but having an effective treatment would do wonders for the overall psychology of the country and the world. At the moment the "voting machine" is running on optimism.
Eventually, likely once we start reopening parts of the economy the markets will start to act more like a "weighing machine". The news on Friday impacts not just the short term optimism but could influence the long term economic data. Why? Having an effective treatment likely takes the worst case scenario for markets (a prolonged shutdown or return to normalcy) off the table, and therefore changes my view by reducing the probability that the market will take out the March lows. It does not mean that the volatility is over or that we won't still have substantial drops in the coming days. The reason is the "weighing machine" is still broken. Investors can’t accurately quantify the impact that the shutdown is having on earnings until we get reopened. There’s not enough information available to accurately project what demand and consumer behavior will look like once we reopen. It means that at the moment, stock prices are being determined based on incomplete data and therefore, those prices are unstable. As new information emerges, the "weighing machine" side of the market will take it and project future earnings and this causes adjustments to a stocks fair price. Spikes in stock prices – both up and down – will occur as markets seek the “right” price for every stock. To that end, the new information we received this week confirmed what was already assumed, here's what we learned:
So what's the moral of the story? Be excited about the progress on the public health side of the crisis and be optimistic that better days are in front of us. However, don't get too excited about the comeback in your growth assets as the markets still have no way of knowing how long it will take for economic activity to resume to normal or what the impact of all this will be on the economy and on corporate earnings.
As always, stay safe and I look forward to meeting with you once things get back to normal. Financial Advisor Stephen Caruso is here to help at any time. If you would like to schedule a phone appointment. I have included a link to my calendar below and you can self schedule.