Current stock market sentiment on Wall Street is that the Federal Reserve will do whatever it takes to keep the rally going, but what happens when that isn’t enough?
Fed Chair Jerome Powell spoke in front of Congress on Tuesday, once again repeating the bearish economic risks that sent the stock market spiraling last week.
“The levels of output and employment remain far below their pre-pandemic levels, and significant uncertainty remains about the timing and strength of the recovery,” Powell said in his prepared speech. “Until the public is confident that (COVID-19) is contained, a full recovery is unlikely.”
The stock market sank after the announcement Tuesday morning, but it didn’t last as investors continued to celebrate a record comeback for retail sales in May. Sales increased by 17.7% last month as the economy began reopening amid the pandemic.
Banyan Hill Publishing economist Ted Bauman says the current state of the U.S. has created a stock market “based almost entirely on sentiment.”
“It has to be since, as Powell acknowledges, there is too much uncertainty about economic recovery to base trading strategies on fundamentals,” said Bauman, Editor of
But the problem with a sentiment-driven stock market, he warns, is that it’s “inherently volatile.”
“It’s like a flock of starlings flitting from one direction to another rapidly. Positive sentiment is based on the Fed’s support for capital markets. Negative sentiment is created whenever there are a few headlines reminding people of reality,” Bauman explained. “That’s why we see these crazy daily swings back and forth between recovery stocks like cyclicals and lockdown stocks like Zoom.”
While the Fed has pledged to do whatever it takes to keep the economy and markets going, Bauman notes it’s important to keep expectations in check.
“The positive market sentiment that says the Fed will save everything is badly misplaced,” he said.
Powell echoed that notion when addressing the central bank’s plan for purchasing corporate bonds Tuesday.
“It’s out of an excess of caution to preserve these gains for market function by following through,” Powell said. “It’s really going to depend on the level of market function. If the market function continues to improve, then we are happy to slow or even stop the purchases. If it goes the other way, we will increase.”
Nowhere in that statement does Powell mention pushing bonds to incomprehensible levels. And that’s why Bauman thinks investors and overall market sentiment should remain cautious while still looking for opportunities.
“It’s appropriate to expect Fed intervention to bring the stock market up to a reasonable level relative to its previous trend performance, but not back up to historic highs,” Bauman said. “And yet incautious investors keep pushing it in that direction. Because the overall level of the market is higher than justified, given fundamentals, the downswings we see are violent and unpredictable.”
That’s exactly what happened when the Dow Jones Industrial Average cratered almost 7% on June 11.
Bauman and his subscribers to The Bauman Letter, a service that focuses on protecting wealth while increasing investment earnings, have been finding success amid the volatility while also maintaining reasonable levels of risk.
“In a context like this, my advice remains the same as it’s been all along,” Bauman wrote via email. “First, buy real value, but take profits often and be psychologically strong about the inevitable downdrafts. Second, look to secure big long-term yields by buying unfairly beaten down dividend-producing stocks like REITs, closed-end funds and BDCs (Business Development Companies).”
His last piece of advice goes out to all the folks investing in companies like Hertz Global Holdings Inc. (NYSE: HTZ).
“Third, don’t buy stupid stocks like bankrupt companies,” he added. “That’s not investment, that’s gambling.”
If you’d like to hear more about what Bauman thinks about market sentiment, and this “gambler’s stock rally,” check out his recent video below. Be sure to join the conversation with nearly 22,000 subscribers at his YouTube channel to know when his latest insights drop.
