I had never really considered the recent bull market state of investing until I heard someone say, “Investing has become almost a religious activity.”
I had to stop and think about that for a minute. But the more I thought about it, the more it made sense.
My friend and Banyan Hill Publishing economist Ted Bauman said it during a recent discussion and it resonated with me.
In the past, analysts debated the direction of the stock market based on how they viewed various fundamental and technical data.
The arguments were rooted in reality and facts.
Today, however, it seems this bullish investing is based on pure faith.
“If you’re cautious and skeptical, as I tend to be, then you don’t believe in the coming V-shaped recovery,” said Bauman, the Editor of The Bauman Letter. “Your demand for proof marks you as a doubting Thomas.”
But this new faith-based form of investing is flawed.
The Bull Market Holy Trinity
According to Bauman, investors who have become bullish on the state of the economy and the stock market generally have three “articles of faith”:
- The coronavirus pandemic is over and everything is getting back to normal.
- The Federal Reserve intervenes directly in mortal affairs to ensure stocks only go up.
- If stocks look overvalued, it’s because earnings haven’t returned to normal. But eventually they will. Those faithful investors are buying those future earnings now.
Let’s examine each of those articles.
No. 1: The Coronavirus Pandemic Is Over
The seven-day average of coronavirus cases surged 30% week over week.
Dr. Anthony Fauci, the top U.S. infectious disease official, said the next two weeks could be critical in containing the outbreak.
More importantly, consumer behavior is a key indicator that this pandemic is far from over.
Bauman said restaurant bookings are 60% below their pre-COVID levels, even in lockdown-free states. Discretionary spending, hotels, sports and public entertainment aren’t faring much better.
Let’s not forget the airline industry, which Bauman said only exists because of federal bailouts that won’t last.
“Remember, every dollar not spent is a subtraction from future economic activity — not just for restaurants or airports, but for their suppliers — and their suppliers — and so on,” he said.
No. 2: The Fed Will Ensure Stocks Keep Going Up
It’s no secret that the trillions pumped into the economy by the Federal Reserve has propped stocks up and made investors bullish.
The plan to backstop corporate debt caused junk bond yields to rise. The increase in debt issuance has halted bankruptcies — for now.
But the Fed has put very little cash into debt markets. Just announcing it was prepared to do so was enough to convince investors to do the heavy lifting and spend their own money on corporate debt.
However, the Fed continuing this trend indefinitely is unlikely.
The Federal Reserve Act of 1913 prevents the Fed from buying corporate debt directly. It is restricted to government debt.
“Second, as the Fed’s balance sheet grows from bailouts to the corporate sector, so too will pressure to extend the largesse to Wall Street,” Bauman said.
In short, that one thing propping up Main Street and bull market sentiment is likely to go away.
No. 3: Buying Future Earnings
Of the bull market holy trinity, this is the most illogical.
Stocks today are overvalued. Near-term price-to-earnings ratios are 99% of their previous highs — which were set during the dot-com bubble.
“The bulls justify this by saying earnings will bounce back,” Bauman said. “Investors are smart to anticipate that, the argument goes.”
However, the time frame investors usually use is about 24 months. So if current valuations are justified based on earnings levels two years from now, where do those stocks go in the meantime?
“They can’t go up much more without reaching irrational P/E ratios, even based on a 24-month time frame,” Bauman said. “The only way they could keep going up sustainably is if future earnings are expected to increase — which is completely unknowable now — or if we lengthen the time frame.”
So unless investors are willing to make decisions based purely on faith, a substantial rise in the stock market isn’t going to happen.
“As I’ve said before, a sentiment-driven market is inherently volatile,” he added. “All it takes is a few bad data points or negative headlines to bring about a sharp correction.
“And there’s no shortage of either these days.”
The Takeaway
You can’t ignore these headwinds. To do so would be foolhardy and will end up costing you money.
The key here is to invest with your head, not your emotions.
Do your homework and be smart. Don’t focus on the headlines, focus on the companies themselves.
It seems like a no-brainer, but oftentimes it’s a difficult prospect for investors to take the emotion out of investing.
Don’t bank on faith when it comes to where you put your money.