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The Socratic Mob

Updated: Jul 20, 2023

James Madison spent the year before the Constitutional Convention researching the history of failed democracies. He wrote about one of his findings in The Federalist Papers: “In all very numerous assemblies, of whatever characters composed, passion never fails to wrest the sceptre from reason. Had every Athenian been a Socrates; every Athenian assembly would still have been a mob.”

In order to keep the government from becoming that mob, Madison incorporated numerous checks and balances into the Constitution. The Framers took extreme care to insure that, during times of ideological extremism, things would get slowed down. Federalism is the cornerstone of the Constitution and continues to promote ideological diversity. Plus, the stock market loves it.

LPL Research, Bloomberg 1/31/20

When you combine the third quarter’s better-than-expected earnings with the predictability of political gridlock and Pfizer’s vaccine headlines yesterday, things start to look pretty good for bulls.

According to LPL Research, another strong week of results has put third quarter S&P 500 Index earnings on track to fall just 7.5% year-over-year, more than 13 percentage points above September 30 estimates, and forward 12 months’ estimates have increased by 1.6% since September 30, bucking the long-term pattern of reductions during reporting season and setting up a strong earnings rebound in 2021.

The stock market is a remarkably efficient anticipatory mechanism, so perhaps it’s not all that surprising that the S&P 500 added more than 1% on four consecutive days last week. But this is only the fourth time that has happened Since World War II —the others were April 1970, October 1974, and October 1982. Future returns after those three instances were all quite bullish, up more than 20% on average a year later.

A little more historical reference: One week after losing 5.6% (worst week since March), the S&P 500 bounced back and gained 7.3% last week (best week since April). This type of move is quite rare, last happening in March 2009 and March 2020, and led to continued higher prices in the near-term in both instances.

Pfizer’s announcement about its vaccine is just what the doctor ordered for those segments of our economy that were not participating in the Q3 earnings rebound, and it served as a slingshot for stocks yesterday. The first analysis of their clinical data by an outside panel of experts found that the vaccine was more than 90 percent effective in preventing the disease among trial volunteers. If the results hold up, that level of protection would put it on par with highly effective childhood vaccines for diseases such as measles. Additionally, no serious safety concerns have been observed.

It’s just what we needed, and it means that we can shift our sights. Among other things, we'll be watching the Senate races in the state of Georgia and their January 5 runoff. There are plenty of reasons to be bullish, but anything to derail the Madisonian checks and balances of a mixed Congress that resulted from the election would be, in our view, disconcerting for investors. Wall Street will be watching Peachtree Street, to be sure, but we don’t think that’s going to restrain stocks much.

Based on our belief that the U.S. economy is on the cusp of another multi-year bull market, we continue to recommend that investors stay invested within a risk management framework and a strategic asset allocation focused on small- and mid-cap stocks.

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