In the stock market against sentiment, it’s all about the money supply | The smartest investor

Recent city and state closures have shut down countless businesses nationwide, resulting in widespread unemployment.

As a result, consumer confidence fell in April, according to the oft-cited University of Michigan index, before rebounding slightly in May, and a survey by the American Association of Individual Investors hit bearish lows.

Despite this, stocks have skyrocketed after hitting a low in mid-March, rising nearly 40% since then.

Therefore, the million dollar question that worries almost every investor is: Why have the markets soared so high even though sentiment remains so low? For many, this decoupling is not only difficult to reconcile; it’s impossible.

This dynamic, however, is not entirely unusual. Investor sentiment is often at odds with the markets. Investors are impulsive and emotional, often selling when they should be buying and vice versa.

Part of that helps explain what’s going on. The other important factor is monetary policy.

Monetary policies

As hard to believe, now that states have started to ease foreclosure restrictions, it’s reasonable for the S&P 500 to turn positive this year or early next year, and may even hit new highs.

If this happens, it won’t just be due to improving corporate profits or better consumption figures. It all comes down to the current cash boom.

With the Fed buying treasury bills, agency mortgage-backed securities and, for the first time, corporate bond exchange-traded funds, the M2 money supply – which is essentially the amount of convertible liquidity that exists in the market – has climbed about 18% in two months.

It’s a huge leap. For context, between mid-2008 and mid-2009 – at the height of the last economic crisis, when the Fed also embarked on an easing frenzy – the money supply shrank. It didn’t start growing until March 2010 and only grew at about half the current rate.

Federal Reserve Chairman Jerome Powell and leaders of Congress are pushing for more fiscal stimulus. The fact that 2020 is a presidential election year makes further help much more likely.

Nonetheless, the existence of easy money, along with the promise of more of it, continues to be underestimated.

This is why the actions are currently exceeding expectations. This is also one of the reasons the markets performed so well at the end of last year and early 2020.

At the time, most observers believed that clarity on trade policy was helping the hike. But what has been somewhat overlooked is the fact that the Fed’s balance sheet rose 11% between September 4 and February 12, as it embarked on a moderate version of quantitative easing to counteract. a possible trade war between the United States and China.

This led to a period of outperformance for cyclical / value sectors at the expense of secular growth names like Amazon (ticker: AMZN), Microsoft (MSFT) and Salesforce.com (CRM). Notably, nothing happened that could cause anyone to question the fundamentals of these companies, but the move marked the start of a widespread rally.

Cyclical / value stocks

More recently, as money supply has rallied again, we’ve seen exactly the same thing happen, with cyclical / value stocks outperforming secular growth ones. It could bode well for financial, energy and materials companies, although it’s worth taking a look at the scene before jumping in with both feet.

Oil and natural gas prices remain modest and could stay that way for a long time, meaning many energy companies would be a tough bet.

Financials tend to do better when they can borrow at low rates and lend at higher rates. While some believe the new Treasury issuance will lead to higher bond yields going forward, it’s safe to assume that the Fed’s quantitative easing plans include buying almost all new Treasury offers, at least until the economy normalizes.

This leaves materials as perhaps the area with the best opportunity for widespread gains.

At first glance, these companies may seem unattractive, as their price-sensitive products create attractive margins and generate higher dividends during times of inflation. With so many unemployed and businesses closed, the worry now is disinflation – the reduction in the rate of inflation.

But the first signs point to a manufacturing rebound. Activity in China was stronger than expected last month, while readings in the United States showed signs of life after falling off a cliff in April.

A good market indicator to know for sure if these movements could be more permanent is to compare the prices of copper and gold. The latter becomes popular when uncertainty is high and the former when production increases. If copper is starting to gain at the expense of gold, this is something to note.

In this context, three stocks to watch are global construction machinery company Caterpillar (CAT), medium and heavy commercial truck maker PACCAR (PCAR) and paint and coatings maker PPG Industries (PPG).

Their stock prices fell until May, but their products have always been successful, making them potential buying opportunities.

The markets are telling. Despite all the negative data, what they are saying today is that money flows a lot more freely than most realize. This should support the markets in the face of extraordinary obstacles.

About the author