Narratives are important drivers of overall market performance
Multiple narratives can be at work simultaneously
Key narratives for 2021: Covid-19, Stimulus Money, The Banking System, and The Fed
In recent years, stock market research has moved beyond just looking at balance sheets and cash flows. While these data points are important, they are not the only things that drive stocks up and down. There is a recognition that stocks move regularly with the broad market, regardless of, and sometimes in spite of, company specific news. While it is important to look at specific company fundamentals, tracking the changing narratives on the market is critical in today’s environment.
Market narratives are like movies. There are some characters who play leading roles and others that play supporting roles who come and go over time. Who are the main characters in the market’s narrative today? You will recognize most of them:
1) The Federal Reserve (The Fed)
2) The President
4) The Banking System
5) Economic Growth
The supporting characters may come and go, but when they are on stage, they are loud, important and may overshadow any of the main characters for a short period of time. Eventually, the plot changes and they move off-stage or are dealt with by a main character. Some narratives, like supporting characters are transitory. You may recognize some of them:
2) China’s Communist Party
3) Trade Partners
4) Trade War
5) Stimulus Money
6) Tax Policy
7) Election Outcomes
8) Robinhood Traders
9) Mid-East Tensions
10) Euro-zone economic problems
There are several Narratives that are dominant in the market today and a surprising absence of others. First, which are currently the most dominant Narratives? The President, Congress, the Banking System, the Fed, Covid-19, Stimulus Money and Robinhood Traders are the main Narratives to follow in today’s environment.
President Trump has a tremendous influence on the market. In general, his tax policies have been a net positive for the stock market. The trade war was a minor negative, but as he negotiated with the Chinese, every news story hinting at “deal-on-the-table” or “talks-continuing” relieved the stock market and allowed it to rise. Even when the news never came to pass, the market only reacted to the latest headline. In a similar fashion, President Trump has been harshly critical of Federal Reserve Chairman Jerome Powell whenever Fed policy was not seen as stock-market supportive. His rhetoric to the country and marketplace is that of an encouraging coach: we have the greatest economy, the best doctors, the strongest military, etc. Regardless of whether you like him or not, you must acknowledge that he sang sweetly to the markets. President-elect Biden will also have an effect on the market narrative, both good and bad. The markets want his softening of the Trade War, but are slightly nervous about his Tax Policy platform.
Congress also reacts to the market. In April of this year, with the market falling and lockdowns happening across the country, Congress stepped in with an unprecedented stimulus program. The delivery of Stimulus Money helped put a floor under the market in early April and as we progressed through the year, every headline of “more stimulus” or “Pelosi and Mnuchin meet” were enough to rally the market. This dynamic is still in play today, except as a minor negative. There is no consensus for another broad bail-out package in Congress and the market wants one badly.
The Banking System is a quiet and powerful Narrative. Fed policy changes don’t hit the real economy without the Banking System cooperating. Banks lend money to businesses, governments and individuals. When lending expands, the economy grows; when lending contracts, the economy slows down. When banks take losses on their loans, lending contracts severely. Today, there is a risk of this latter situation. We hope the economy is bouncing back, but if loan defaults suddenly pick up, the banks will get very defensive and choke off what little growth has been nurtured by the President, Congress and the Fed.
Covid-19 has been the most dominant Narrative in 2020. We are all familiar with the difficulties it created. While the disease is serious, the market’s concerns over Covid-19 are two-fold: what will governments do to control it and what will be the consumer’s reaction. Cases are rising globally again and countries that thought they had it fixed, like France and Germany, are shutting down. Another global round of shutdowns will be a devastating blow to the global economy. Covid-19 is a dangerous Narrative.
Robinhood Traders are the newest Narrative to enter the stage. Robinhood is an app for trading stocks on your phone. Most investors have been able to do this on their brokers’ platforms for years, but in 2020 speculative trading on the Robinhood platform skyrocketed among novice investors. The use of options and margin trading among this broad group and their tendency to herd together in trading ideas has made them large enough to impact the markets. For now, the Robinhood Narrative is an important one. Historically, however, large retail participation in the markets has not ended well for those getting into a mature bull market.
Finally, the most important Narrative is the one that is missing. The Federal Reserve is largely absent from the news pages over the last few months. Contrast this to the actions they took in April 2020 and September 2019, when they provided enormous stimulus to avert market panic. The markets reacted positively to Stimulus Money that came from Congress and the Fed. For the long-term investor, the best time to invest seems to be when policy makers are in a panic; the time to be cautious is when they are sanguine. Today, politicians are definitely not in panic-mode.
In the coming months, Covid-19 and the Banking System are the key Narratives to follow. Additional Covid-19 lockdowns will hurt the economy and the markets, but draw in the Fed with more stimulus. Similarly, a credit crisis in the Bank System will also be net negative for the economy and markets, but also inspire the Fed to act.
In the meantime, the markets are watching the Economic Growth Narrative closely for any changes.
Robert Lloyd, CFA® is President and Chief Investment Officer of Lloyds Intrepid Wealth Management, and author of the book CENTRAL MARKETS. Since 1994, he has held positions as a trader, analyst, portfolio manager, and wealth manager while working at Invesco, CCM Opportunistic Advisors, and Merrill Lynch. In another life, he served 8 years in the U.S. Navy as a Naval Flight Officer flying in the S-3B Viking. For a complete resumé, visit his profile at LinkedIn.
Rob holds a BBA from the University of Notre Dame and an MBA from the University of Chicago.
Rob is a Chartered Financial Analyst.
Lloyds Intrepid LLC is doing business as Lloyds Intrepid Wealth Management. Lloyds Intrepid LLC offers investment advisory services in the State of Texas where registered and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. Lloyds Intrepid LLC and its advisers do not provide legal, tax or accounting advice. Lloyds Intrepid LLC formulates retirement plans, investment strategies, portfolio construction and investment due diligence for clients with signed investment advisory agreements with us. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All opinions and outlooks are subject to change.
© 2020 Lloyds Intrepid LLC