In the short run rationality is not an especially adaptive trait for an investor.
Remember that.
Take today’s market for example. JPMorgan Chase (JPM) and Wells Fargo (WFC) delivered very sobering news on how the coronavirus and the coronavirus shutdown of big hunks of the U.S. economy had hammered revenue and earnings. Two especially sobering points in those earnings reports: first, the results were for the first quarter so they covered a period before the strictest shelter-in-place restrictions went into effect, and second, the banks reported huge number of deferrals on things like mortgage payments and added billions to their reserves against future defaults. In other words, the worst is yet to come.
But…the market as a whole rallied. Strongly. The Standard & Poor’s 500 closed up 3.06% after a week in which it gained 12%. The Dow Jones Industrial Average gained 2.39%. The NASDAQ Composite soared 3.95% and even the Russell 2000 small cap index was higher by 2.09% at the close. The iShares MSCI Emerging Markets ETF (EEM) gained 2.29% by the end of New York trading.
Why? Because the market decided that all that was important was the promise that in May–maybe even on May 1–the social distancing measures that have done so much to slow the rate of growth of coronavirus cases would be put back in the pandemic tool box. At the least the rules that have so hobbled the economy would be eased. They might even be removed completely. And the economy would relatively quickly return to normal. This is a market and a Wall Street that remains committed to the idea that this will be a two quarter slowdown and that economic growth and corporate revenue growth will bounce back strongly in the third quarter.
Now, I’m convinced that any rational analysis will show that isn’t likely. In fact it’s extraordinarily unlikely. And that those economists and (a few) Wall Street strategists who see the slowdown lasting into 2021 as the coronavirus returns for a second or third swipe at the global economy are much more likely to be true.
But in a market that keeps climbing on what I think is an insane scenario a belief in rationality is very cold comfort.
In fact it can be downright self-defeating. It can, for example, send you back to the data and the science for more rational proof. So you dig into what we know about the coronavirus and about testing and you discover the horrifying “false negatives” problem. The current generation of tests is not terribly reliable and there is extensive reporting of patients who tested negative for the virus once, twice, three times, and even more before a test came back showing that they had the virus. No one seems to know why this is happening. Theories abound including badly administered tests (likely in my opinion), and faulty tests (also likely) and tests that we administered before the virus had clearly manifested itself (unlikely given that patients with clear symptoms are still returning negative test results.) But the really scary thing about what you learn by researching this more is that the false negatives could be as high as 30% and that no one knows for sure.
So Mr. Rationality comes away with a solidly researched belief that even if we could get a program of massive testing in place before we begin easing the social distancing rules (which we won’t, the calendar says there isn’t enough time), we’d still be looking at a very strong likelihood of a second wave of infections as all those false negatives leave their houses and go back into contact with the general population.
It may help your self-esteem to believe that you know something that the market doesn’t. But in the short run that superior knowledge, that deeper research, that more complete understanding isn’t going to put a dime in your pocket as long as an “insane” market keeps climbing on its own overly optimistic read of the situation.
So what do you do?
You don’t abandon your rationality or ignore the facts that you know. Market history shows that in the longer term the market does a reasonably good job of including most of the evidence in its investment valuations. It can just take a while.
Which results in a strategic decision like the one that I’ve out forth in my Bear Market strategy Special Report that you want to try to play the difference between this short-term “insanity” and the longer-term rationality. That means buying and selling now whenever market prices seem significantly out of whack–in your rational analysis–with likely long-term valuations.
That can mean buying gold, for example, if the current faith in a quick V-shaped recovery causes the price of the safe-haven metal to fall back.
It can mean buying puts–with enough lead time till execution date–so that you can eventually profit from the change in market perspective.
It can mean riding current positions higher, even if you think the climb is based on a misreading of the likely medium and longer term future. But keeping an eye on when to sell because you still think your read of the future is correct.
And for the most nimble among us it may even mean an attempt to buy into the market’s insanity to pick up a opportunistic profit here or there. Do remember that this is hard, however, because you’re trading on your read of market sentiment and that can turn on a dime.
This week brings potentially sentiment-changing data on Wednesday, tomorrow, April 15, when we’ll get reports on U.S. oil inventories that are likely to show a depressing build of oil in storage, and also tomorrow when we’ll get the Commerce Department’s report on March retail sales. That won’t be optimistic reading either, I fear.
And then on Thursday we get another weekly report on initial claims for unemployment that’s expected to show another huge surge of job losses.
Sprinkled in there we’ll also get more earnings reports, including more big bank news from Citigroup (C) and Bank of America (BAC) on Wednesday.
Time to regroup on Friday, I think, to see if this “insane” market has given us any opportunities for a profit or two.
More in this vein tomorrow including a post “It’s so hard to do nothing, so let’s do something.”
