The COVID Epilogue Is Coming For Us (And It's About Time)

The COVID Epilogue Is Coming For Us (And It's About Time)

June 28, 2023

It's official, we are now halfway through 2023 here we are with the S&P 500 up around 12%. Who'd thunk? I mean with 10 rate hikes back-to-back, the Russian war, Chinese tensions, and rampant inflation- just to name a few.

In Barron's over the weekend, the Up & Down Wall Street column started the paper with the article titled, "Take It to the Bank: There Won't Be a Recession This Year." Well, they said it in Barron’s, so I guess it's got to be true. The article started with comments on Warren Buffet who was quoted once again as saying, "Never bet against America!" The article finally had a tone of optimism to it, something that has been lacking as the broad market has effectively been climbing a wall of worry. They even brought up a podcast by columnist Zachary Karabell titled, "What Could Go Right?"

Yes, the investing season seems to be changing a bit. I took a lot of time last week going over the desirable market action of other sectors and companies joining the party of the Magnificent Seven. I believe that if this market is to be able to continue its advance it would need to broaden. This has begun happening. And this week began with the Magnificent Seven taking a bit of a breather while the heavy industrials began to break out to the upside. If you would care to see it, simply bring up a chart of the Dow Jones Transportation Index.

So let’s briefly recap history; If we harken back to 2019, the market traded a bit spotty. Then COVID hit in 2020, stocks dropped, a money balloon was dropped on global economies, and the markets rallied. This money balloon was historic as it was the fastest increase in money supply ever seen. 2021 benefited from this until the Fed said, "Hey folks, since we didn't go into full depression, it is time to tighten things up and we are going to squash money supply and make sure the US doesn't go into an inflationary spiral." 2022 was a digestion of March 2020 to November 2021 doubling of the market. Then came 2023. More of the same was expected in 2022 as the Fed continued its tightening. 

The markets are driven by greed and fear. Normally fear prevails. It is the most common as it is fear that sells papers and advertising on news channels. In looking at a measure of fear, I use the Sentiment Index, which is the AAII (American Association of Individual Investors) % Net Bulls. This index measure is reversing the longest-ever bearish stream going back to 1988 (when it started). See below the chart since 2016 to accentuate how truly bearish it has been of late. 

At the same time, there was a very interesting phenomenon going on. Due to a combination of fear and multi-decade-high short-term interest rates, cash levels built up to huge levels. Currently, there is $5.5 trillion now on the sidelines, even more than the $4.7 trillion that was on the sidelines just six months ago. So, think about this, even though the equity market is up some 13%, the amount of cash on the sidelines has continued to grow! See below the amount of this cash that was in institutional money funds and retail money markets going back to when the money balloon dropped in 2020. This is due to several factors, but what is most important is the sheer volume of cash that is out there needing a home in some longer-term investments. 

The next chart I feel is the most important one in this measure of the concentration of cash balances. It can be seen below that the majority of this $5.5 trillion is concentrated in the top income quartiles. I find this not often mentioned but incredibly important. What this is saying is the top quartiles are squirreling away their cash balances in short-term cash instruments because they can attain over 5% interest on their money fully insured by the US Government. And just think about what happens to stock prices if they decide that 5% doesn't make them happy anymore and they want to participate in a market that they hope does what the S&P 500 did in the first half of 2023. This could be a kind of blast-off moment. 

On top of the highest income quintile having the largest amounts of cash, also remember that the Social Security benefits for 2023 were raised at the highest rate since 1981, some 9% increase in monthly Social Security income. This is one heck of a pay raise for those on Social Security and this group is only getting larger as our population statistically is getting older. More people getting more money, for longer. Again, this a pretty good recipe for consumer spending, on top of the massive cash balances. On the cover of the Wall Street Journal, Monday, there was an article titled, "Diners Lose Patience With Restaurant Service." I sort of read between the lines on this. We have more cash, earning higher rates on the cash, on top of higher incomes from Social Security and it is being reflected in restaurants, food, and travel. Just last week, Airbus, the European airplane manufacturer, reported the biggest backlog in planes in its history. 

But what about all the programs that the current administration packed into the national budget in the last two years? Kevin Pollari, head of Deloitte's Infrastructure & Capital Projects program brought up in Barron's, "But the most positive fact, certainly over the longer term, is the under-recognized $2 trillion of spending from Washington in three bills: 1) the Infrastructure Investment and Jobs Act, 2) the Creating Helpful Incentives to Produce Semiconductors and Science Act, and 3) the Inflation Reduction Act." He went on to say, "It has catalyzed so much activity that it's really kind of mind-boggling. As I go around meeting with metropolitan planning organizations the amount of projects is really, really stunning." 


Last week, I also mentioned that there is a very interesting thing going on in the real estate market. Existing homes are selling at a very slow rate, yet new home sales recorded the highest monthly increase in May in history. The message is quite clear, why would somebody sell a property that is being financed at 2-3% interest and move the money into a new property costing 6-7%? Just doesn't make sense, hence very few existing homes are being sold unless it is needed to do so or was a 1031 exchange necessity. 

In closing, the question I am getting is now that the markets have gone up as much as they have, what is expected for the latter half of 2023? Well, good news once again! Since 1950, there have been 22 instances when the S&P 500 was up over 10% by mid-year:

  • The median second-half return is 8%, with an 82% win ratio.
  • Implies S&P 500 4,700 by year-end.
  • But if the previous year was a negative return year......
  • There were nine of these 22 instances, and the second half was 12% or higher, with an 89% win ratio!
  • This would imply an S&P 500 of 4,900. 
  • The only exception was 1975, but in 1975 the first half of the market was up a scalding 38%.


If we were to focus on the Magnificent Seven (which are around 51% of the weighting of the NASDAQ 100) since 1986, the NDX has posted its best month returns when trading at least 20% above its 200-day average (as it is currently). This tends to indicate that price momentum has been particularly effective when this benchmark has been achieved. 


There are certainly going to be corrections along the way, but if history- the last 60 years of history- can be used as a guide, there is plenty of liquidity, plenty of consumption, and plenty of cash to fuel the expansion. 


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