Over the past month, the focus has shifted from policy and earnings to retail trading dynamics, which has led to some interesting price action in certain corners of the market. In a recent investment piece, we noted that our recommendation has been to avoid equities with poor fundamentals that are receiving a lot of hype because these are often “flash in the pan” type situations and can reverse quickly. Consistent with that, the companies dominating the news cycle a couple of weeks ago, largely propelled by a frenzy of retail speculation, are now trading 50-80% below their recent highs in just a matter of days.
In times like these, it’s particularly important to keep long-term financial goals top of mind, and to invest in high-quality assets that will stand the test of time. There are various explanations for why markets are behaving the way they are, one being that excess liquidity provided by Central Banks is becoming trapped in the financial system, causing a dislocation between fundamentals and valuations. To give context to just how much liquidity the Fed is providing, we have provided the chart below, courtesy of the St. Louis Fed, which shows the rapid increase in money supply (M1 Money stock, i.e. supply of currency in circulation). Clearly, these are unprecedented times.
Looking forward, we expect another fiscal package to be passed in the first quarter, although we think that legislation will be more targeted than prior stimulus packages. Much of this has probably already been priced into markets at this point, hence the increase in small-cap equities over the past couple months. Overall, we remain cautiously optimistic. The optimism being driven by continued monetary and fiscal policy support, the caution being driven by valuations and investor behavior that are reminiscent of the 2000 tech bubble experience. The parabolic rise and subsequent crash of the Reddit stocks over the past couple of weeks brings to mind the famous quote from Jack Bogle (founder of Vanguard), in which he said, “be learning every day, but especially from the experiences of others because it’s cheaper that way.“
