Year-End Market Update & Concerns for 2021 with CIO John Benedict of J2 Capital Management

John Benedict


2020 will forever be remembered for both the pandemic that was unleashed upon the world as well as the policy responses to it. Investors will also remember it for the tremendous market volatility (in both directions) and more importantly, investor’s reactions to that volatility (again, in both directions!). 

The first quarter of the year saw investors reacting in a time-tested manner to lower stock prices known as "get me out at any price".  Who could blame them, but the timing of the fear couldn’t have been worse as the bear market lasted a little less than just 60 days. If you are noticing a trend the past few years where market corrections and bear markets last only a few weeks instead of the historical months to years, you are not alone. These are not your father’s bear markets anymore – thank you Jay Powell and the Fed!

By the fourth quarter, however, we went to the other extreme which can be summed up as the quarter where investor psychology went from "get me out" straight to "fear of missing out", or said another way; I do not care what I am paying for stocks I just want in.  A round trip of investor emotion indeed.

Seen as a once in a lifetime opportunity at the bottom in March, an army of millennial investors took the markets in much the same way they played video games growing up as youths.  With seemingly no risk tolerance and treating money the same as having additional lives in Call of Duty, they leveraged up into the market. This created a massive positive feedback loop, otherwise known as momentum which then brought most participants rushing back into the market. Nothing fixes a negative outlook on the market quite like higher prices. In future blog posts, we will be writing on a concerning trend taking place that is treating stocks much like an entertainment event, or gambling on sports without regard to stock company fundamentals.  Should we be concerned?

Market Climbs Wall of Worry in the 4th Quarter

Of course, there were and still are, multiple concerns that remain in the market. The 4th quarter saw a tumultuous election that split the nation causing perceived incremental risk in stocks.  Of course, the never-ending virus and lockdowns were also top of mind.  These concerns had no impact on the market, as the relentless rally broadened out from technology stocks to the economically sensitive cyclical and value stocks that had lagged so badly the previous 6-8 months.  The market was able to look through these concerns with the expectation of brighter days with progress on the vaccine front, as many have been approved and are starting to be shipped around the world.

Stimulus and Pavlov's Dog

Just as Ivan Pavlov’s conditioned dogs to salivate by ringing a bell, it has become apparent that investors have conditioned themselves to the slightest smell of Federal or Fiscal stimulus.  I recall writing about this conditioned investor response back in 2012 but others in my industry were not as sure that there was a link between stimulus and stocks. I think we can put this debate to rest now as it has now become widely accepted.  As the bell ringing elicited a powerful salivating response to Ivan Pavlov's dogs so does the response to both Federal and Fiscal stimulus produce a similar salivating response for investors.  The 4th quarter saw more continued stimulus talks that drove investor behavior to grab more stocks.

Laggards Become Leaders

Early on throughout the year and early on we noted how technology stocks were the only game in town leaving small caps, cyclicals, and value stocks in their dust.  The 4th quarter saw some major catch-up of these economically sensitive areas as markets pinned their hopes on vaccines and economic re-opening. 

Too Far too Fast: What Could Go Wrong?

Market participants are getting absolutely giddy here about the market looking for their next opportunity to double their money, and hopefully doing it in less than a week! Many participants are playing stocks like they would a slot machine at the casino.  If the slot machine is not hitting, then just move on to the next one.  We are also starting to notice a trend where some long-term investors are ratcheting their risk levels incrementally higher as the market goes higher. This behavior typically occurs during the speculative phase of the market. Textbooks call it the mania phase, which has this habit of going on longer than anyone thinks possible.  Market technicals and underlying strength across stocks are suggesting loudly that we may be in the early innings of a multi-year bull market, though it is doubtful that technicals mean much anymore in an environment where runaway momentum and a strong belief system in free money is all that matters.

We at J2 Capital are curious about these market movements and what is driving stocks higher at this point. It's apparent that no one is looking at company valuations or what prices they are paying here. We are growing concerned that the current market dynamics and forces propelling stocks higher may not last and likely will end with a period of increased volatility, possibly soon. Like in 1999, we are seeing a new wave of calls saying, "It's different this time". A new breed of economists and stock traders are touting the wonderful and seemingly bullet-proof theories of Modern Monetary Theory (MMT) where no amount of National Debt or cataclysmic event could keep stocks down for long when world governments have access to a money tree.  History has been very unkind to those believing this.  Also, many of the new breeds have never invested in anything but a bull market.  

In the end, we suspect that the party may have a few more months to go but what comes next will likely be a similar result to what we saw in 1999.  I suspect there are a lot of new-age economists and traders that will be shocked when it happens, not me. 

I leave you with a quote from former Citigroup CEO Chuck Prince back in 2007 said “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said. The quote is from July 2007.  Chuck Prince was out as CEO months later as one of the worst bear markets in history was taking place. The bet being placed today is the liquidity will never stop and thus stocks can continue to drive higher infinitely regardless of valuation.

In the next few months, we will be writing about the unnatural forces moving stock markets today and how we are preparing portfolios and attempting to manage risk. Please subscribe to our updates.

By John Benedict

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