“Resilient” is a word that I have used in the past to describe this market, and what we are seeing in early trading this morning reinforces just how apt a word it is. Think about it for a minute: Over the weekend we have seen one of the most powerful, largest storms ever to hit U.S. shores, right on the heels of the last one. Hurricane Irma has resulted in an estimated 5.9 million power outages so far and flooded many low-lying areas. There is also more to come as Irma heads into Georgia and the Carolinas as a tropical storm.
And, in a move that one might expect to rattle markets somewhat, North Korean leader Kim Jong Un seemed to be threatening all-out war when he said over the weekend that his country would inflict “pain and suffering” on the west for imposing sanctions. Stock futures, despite all that, are indicating a sharply higher opening in all the major indices, bringing new record highs back into view.
To those who have listened to the headlines and seen the video footage over the weekend, that may be mystifying. For experienced traders, however, it is an example of something that they will have learned quickly, even if often at great cost. When it comes to the market’s reaction, the content of the news is not relevant, what counts is the prevailing mood before it breaks.
There are two ways to look at the events of this weekend. The obvious one is to say that the storm is going to disrupt economic activity in a large swath of the country and put a dent in already low GDP numbers, and that Kim Jong Un’s rant draws us ever closer to a war that could involve nuclear weapons. Kim Jong Un cultivates an unpredictable image. Who knows how far he will go to maintain that?
The market’s seeming disregard of the possibility of war ignores the fact that even if the chances of are low, the potential consequences should it happen are massive.
When it comes to the domestic economic issues the market is also displaying an optimism that ignores some possibilities. In the optimist’s world, the rebuilding that follows the devastation will give a long-term boost to Florida’s economy and result in much needed improvements to the state’s infrastructure. The storm may even catch the attention of the Fed and delay further rate hikes, allowing corporations to continue to borrow at rates that essentially amount to free money.
Add in a bipartisan tone from Washington in response to the storm damage that raises hopes for swift action on taxes and “Buy, buy, buy!” doesn’t seem such an illogical reaction after all.
There are many reasons for traders to ignore the devastation, fear and destruction that the rest of us see in the weekend’s events, but are they really logical? You can argue all you like that the damage is a short-term setback in a long-term period of strong growth, but that is to ignore the effects that will inevitably follow.
That long-term growth is not about the economy, it is about corporate profits. If the stock market was simply about economic growth the S&P 500 would have been rising at around two percent per year since the recession ended in 2009, not the fifteen percent or so average that we have seen.
The difference comes from the fact that a disproportionate amount of that growth has been retained by corporations as profit. The nature of the recession naturally prompted a desire to shore up cash reserves and a reluctance to invest heavily in anticipation of robust growth. The result has been massive cash generation, increased dividends, and stock buybacks, all of which have driven stocks ever higher.
In that context, the long-term outlook is not as rosy as it seems, but that doesn’t mean that you should be looking to buck the trend. The kind of optimism that can shrug off multiple, massive hurricanes and the threat of nuclear war is not to be messed with. It can continue to drive us higher for some time, but investors should keep one thing in mind. The more bad news we ignore, the bigger the drop will be when it does come.
The best strategy therefore appears to be to stay invested, but with some insurance. It may cost you money to stay long of something like VXX, but it is still a smart thing to do. As the market continues to see only the silver lining you will be making more than enough to offset those losses and you will be protected against the time when traders suddenly see the big black clouds.