Investors and money managers are baffled by today’s markets. Corporate valuations, price / earnings ratios and many other standard tools used to evaluate stocks no longer apply. Some blame fluctuations in securities on the COVID-19 pandemic. Others reformulate more standard tools but stretch the bounds to justify their results. I say don’t overthink what you see. The “central banks” are in control. Simply follow their leads and say thanks.
Take Japan as one model. Many found it hard to believe when the Nikkei 225 reached an intraday high of 38,957.44 on December 29, 1989. It had grown a startling six-fold during the 1980s. Twice in 2018 and again in late 2019 / early 2020 it recovered from multi-year lows to breach the 24,000 level. What finally helped the Nikkei maintain its recovery? The Bank of Japan (BOJ).
Like any central bank adds or withdraws, the BOJ maintained liquidity through interest rate related markets. But unlike most central banks, the BOJ began buying stock ETFs in 2010 with the Nikkei 225 trading around 8,000. Under Haruhiko Kuroda, the current BOJ governor, the BOJ, increased its annual purchasing to ¥1 trillion when he first took office on March 11, 2020. The Nikkei 225 has gone up threefold since.
Over the past few months, likely due to the COVID-19 pandemic, the Federal Reserve has mimicked the Bank of Japan. In the middle of June 2020, the Fed, directed by the CARES Act, began buying individually listed corporate bonds. They primarily bought bonds of the largest publicly held listed securities. We speculate that the Fed has been “frontrunning” their own debt purchases by first taking equity positions in these targeted companies before they bought bonds.
With no direct evidence of the above, the performance of three major indices provide pretty good clues. The ups and downs of the Nasdaq, the Dow Jones, and S&P 500 are likely influenced by the bond purchases of the Feds. These indices aren’t operating as usual. Upside moves are exaggerated while downsides are limited as if someone is stepping in to prevent a cataclysmic decline.
Imagine a tall building with three elevators; the Nasdaq, the Dow Jones and the S&P 500. The elevators are high speed. The NASDAQ elevator seems to move the fastest so you take it on Tuesday You press “G” but it stops at 4. You keep pressing down but it won’t budge. You walk out of 4 and discover it is the new ground floor. The “FAANG” stocks, which comprise about 20% of the Nasdaq index, are setting new highs day after day. So, you keep taking the same elevator on Monday, Tuesday and Wednesday to new and better penthouses. On Thursday, the Nasdaq elevator does not work, but the Dow Jones does and on Friday it’s the S&P’s turn almost as if they are playing catch up. The outcome is the same. Next week, the Nasdaq take the lead again, but then it is the other two. Lather, rinse, repeat.
In prior bull market runs or rallies in bear markets, “Small Caps” follow the leader. Not true today. Many of the Russell indices lag well behind. The Fed is not buying up their corporate debt or equity shares. This illustrates my belief that the Fed is frontrunning its corporate bond purchases by first acquiring sizeable positions of underlying large cap stocks.
Chances are the equity markets are going higher. Remember, the Nikkei 225 increased threefold threefold between 2013 and 2020. The Fed’s now operating as the BOJ did. Continue to get on at the lower floors and enjoy the ride up.