B. Riley Advisor Talking Points: The Odd Couple: Gold & Stock Market Reaching New Highs Together
Year-to-date, the S&P 500 Index is up 4.4%, and for the past year, it is now up 18.74%. The tech-heavy NASDAQ Index is up year-to-date 22.81%, and it is currently up 41.75% for the past year.
S&P 500 And NASDAQ Indexes At All-Time Highs
The S&P 500 Index has been near all-time highs this past week and is currently less than half a percent away from its last all-time high set on February 19, 2020.
During this time, we have experienced one of the worst recessions ever, gone through one of the most significant bear market declines, as well as history’s fastest stock market rally and recovery. This has all happened while millions of people have lost their jobs, and tragically, almost 170,000 Americans have lost their lives (John Hopkins).
This is unlike any other recession in history since it was started by a horrible pandemic and happened because people were told by their government to stay inside. The impact of the lockdown was the worst contraction in gross domestic product (GDP) last quarter that anyone has ever seen.
But during that time, the NASDAQ Index has made 30 all-time highs so far in 2020, while the S&P 500 Index has made gains for four consecutive months, all while the unemployment rate remains above 10%.
Why Is This Happening?
- The stock market is a leading economic indicator (LEI). Stocks seem to be forecasting a more robust economy later this year and through 2021.
- The second reason is the massive amount of stimulus that has been pumped into the U.S. economy by both Congress and the Federal Reserve. This infusion of money has helped equity prices to rise.
- Most of the U.S. economy is recovering nicely. This past week, U.S. retail sales regained their pre-Coronavirus levels. Retail purchases rose 1.2% in July, with solid gains in appliances and clothing. This increase helped restore sales to their level before the pandemic closed the economy in March.
Here are two ways of looking at the health of the underlying U.S. economy. The first is the ECRI Weekly Leading Index of leading economic indicators. The second chart is the New York Federal Reserve’s Composite Weekly Economic Index.
As you can see in the charts above, the recovery is starting to slow, and that was before U.S. unemployment insurance stimulus support expired.
With This Slowing, The Stock Market May Now Be Overvalued
The economy is still growing and expanding, but at a slower rate. At the same time, the market may become more volatile between now and the election.
According to Factset, the forward 12-month Price Earnings Ratio (P/E) for the S&P 500 Index is 22.3. That P/E ratio is above the 5-year average of 17 and above the 10-year average of 15.3.
Investors should not be surprised to see a 10% or more pull-back or correction from current prices over the next few months. This would be a normal, healthy reversion to the stock market’s long-term trend of between a 15 and 17 P/E ratio.
What could set off this correction? Almost any negative press could start the correction. It doesn’t take much for investors to take profits in an overextended stock market.
Once the correction is complete, I expect the bull market to continue to broaden out as the economy continues its recovery, and earnings to continue to outperform later this year and into 2021.
Making Sense Of It All
This past week, LPL issued an LPL Research Report that I thought offered an excellent explanation of how the U.S. economy can look like it is struggling while the stock market keeps moving higher. Here is a summary of the report:
- The pandemic has an end date. Markets are looking forward to better days ahead. Although the timing is uncertain, the stock market is expressing confidence that the pandemic will end eventually with a vaccine −or multiple vaccines−and with help from better treatments in the interim. Progress has been tremendous with many shots on goal that are likely to score at least one and maybe more success stories.
- Low-interest rates. Stocks are expensive, no doubt, but they look cheap compared with U.S. Treasuries yielding about 0.5%. When discounting future profits back at such low-interest rates, equity valuations get a significant boost.
- Massive monetary stimulus. The stimulus from the Federal Reserve has driven the money supply, measured by M2, sharply higher−roughly 25% above last year’s levels. Some of that money has found a home in the stock market. Historically, money supply growth and stock prices have tended to move together, which has certainly been the case over the past few months.
- Support from the winners. The so-called stay-at-home stocks have thrived in this environment. We saw evidence of that in the blowout earnings reports from some of the technology giants on July 30. The good news extends beyond those companies, however, with about 40% of the S&P 500 classified as technology, digital media, or e-commerce. Add in some of the most defensive industries within the consumer staples, telecom, and utilities sectors, and more than half of the index is well-positioned for this difficult environment.
The S&P 500 Index Is Not The Same As The Underlying U.S. Economy
The LPL Research Report also went on to explain the distinction between the S&P 500 Index and the underlying U.S. economy and GDP.
“We also think it’s instructive to look at the differences between the economy and the stock market to help make sense of the latest rally in the face of stiff economic challenges. More specifically, the S&P 500 is very different from GDP (gross domestic product) that we use to measure the output of the U.S. economy.
Some of the key differences include:
The S&P 500 is more manufacturing-driven, while GDP is more services-driven. The services economy was harder hit during the lockdowns and, with social distancing, faces a tougher road back than manufacturing.
The S&P 500 is more investment-driven than consumption-driven. Capital investment has been supported by technology spending and has not been hit as hard as consumer spending during the pandemic. As a result, the S&P 500 has been more resilient to the pandemic. We also believe the value of tech-based intellectual property is better captured by the S&P 500 and its profits than the GDP calculation.
The S&P 500 is global, while GDP is domestic. Roughly 40% of the sales for the S&P 500 are derived internationally, while U.S. exports in the GDP calculation make up only 13% of U.S. GDP. The U.S. economy is a net importer, while the S&P 500 is a net exporter, which is why the S&P 500 prefers a weaker U.S. dollar. A weaker U.S. dollar helps make U.S. companies’ goods cheaper around the world and enhances international profits. A strong dollar hurts U.S. exports, but it helps control inflation and supports consumer activity, which is a big part of the U.S. economy.
The S&P 500 likes higher oil, while GDP likes cheaper oil. Profits for the energy sector benefit from higher oil prices, but higher energy costs crimp consumer spending. The industrials sector also generally benefits from higher oil prices through capital spending by energy producers.”
In the LPL Research Report, they conclude by listing the factors behind the strong rally and highlighting the differences between the U.S. economy and the S&P 500. They believe as I do, that stocks will likely be volatile until the end of the year, and we may see this play out in the next few weeks if the White House and lawmakers can’t agree on a new stimulus bill before September.
Why Are Gold & The Stock Market Going Up At The Same Time?
As someone who managed a gold mutual fund for several years, I think gold is an awful long-term investment, but I do believe it has a place in an investor’s asset allocation as an insurance policy.
Over the years, I have watched gold go up 50% and then down 50%. Most investors don’t like or want that kind of volatility in their retirement portfolios. Also, gold can stay at low prices for decades.
But when something terrible happens in the world, gold usually does its job and goes up. As an insurance allocation in your portfolio, it will most often cushion losses from significant downturns in the stock market.
A Short History Of Investing In Gold
- Over the past century, the price of gold, adjusted for inflation, has risen by an average of about 1.1 percent per year, compared with 6.5 percent for U.S. stocks.
- The 10-year U.S. Treasury bond, considered the most risk-free asset in the world, has produced higher annual returns than gold during the last 100 years.
- Gold has always worked as an investment during periods of crisis. It skyrocketed amid the stagflation of the 1970s, rising more than seven times over the course of that decade to peak at $850 in early 1980. It surged again after the global financial crisis of 2008, peaking at $1,900 in 2011, but then it slid back over much of the next decade. In 2019, after the Federal Reserve signaled that it was suspending plans to push interest rates higher, gold went up again.
- The rise in gold prices is also driven by a belief that the easy money pouring out of central banks and government stimulus programs could trigger inflation. However, with technology and global trade and manufacturing as deflationary pressures, many analysts foresee low inflation and low-interest rates continuing for the foreseeable future.
Gold and the stock market often move in opposite directions. Usually, when stocks go up, gold goes down and vice versa. But because of the current investor anxiety and instability caused by the Coronavirus health pandemic and economic crisis, the U.S. elections, and the timing of an expected safe and effective vaccine, I expect to see gold and the stock market continue to rise in tandem through 2021.
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Paul Dietrich, Chief Investment Strategist, B. Riley Wealth Management Paul Dietrich is focused on managing investments for private investors, retirement funds and private institutions throughout the United States. He also serves as a frequent on-air commentator and regularly contributes market analysis to business and financial media including CNBC, Fox Business, Bloomberg TV, CNN, The Wall Street Journal, Yahoo! Finance, Reuters and The Washington Post.
Information and opinions herein are for general use; are not unbiased/impartial; are current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Past performance is not indicative of future results. This is not a research report or solicitation or recommendation to buy/sell any securities. B. Riley Wealth Management is not engaged in rendering legal, accounting or tax-preparation services. Opinions are the Author’s and do not necessarily reflect those of B. Riley Wealth
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