We don’t have to re-hash the story that is this virus and what it’s done to the markets. We know we had one of the fastest market drops in history. We also know last week was the largest one-week rally since 1974. The bounce back from ‘the bottom’ has been remarkable.
The challenge now is figuring out how to make sense of everything. Are we in a V-shaped recovery? Or is this a bull-run in a bear market?
The truth is, we don’t know yet. But here is some editorial opinion on what seems to be taking place.
First, this thing is moving faster than anything I’ve ever seen in the markets. It took 23 trading days for the S&P 500 to fall almost 34%. In the past 13 trading days it’s rallied up nearly 25%. That’s some pretty huge moves over the past six weeks.
Why such massive moves? In a word: guessing.
The major narrative has been one of fear and speculation about the spread of Covid-19. In particular, markets appear have latched onto the news out of New York as the primary indicator for success or failure over this virus.
As both headline fatigue and political manipulation become more significant in the New York story, the markets are starting to shift to the next important thing: earnings. And earnings season is right around the corner now.
Here’s where the rubber will start to meet the road. The market is not as sensitive and caring as you might hope. No, it’s a mercenary predator seeking ways to discern price and locate opportunities. If the news out of New York isn’t going to drive the herds one direction or another, the economic realities that start to show up in earnings will come into play.
There are estimates economic activity could decline by as much as 30%. That kind of number is not something most are ready to actually tackle. Consider this simple math: if S&P 500 earnings were to fall 30%, they would go from estimates of about 180 to 126. If we apply a 15x multiple to that figure, the S&P 500 would fall to 1890. That’s a decline from here of another 32%. As mentioned earlier, we are still only guessing.
We have massive government stimulus on its way. MASSIVE. TRILLIONS!!! And we have massive Central Bank intervention. Again, TRILLIONS!!! This most assuredly will have an impact on things. It is yet unknown as to how much this will help actual corporate earnings. Ultimately, this is the story… stimulus, medical case tracking, shut-downs and target re-opens… all of it is just the market trying to get a sense of how earnings will be impacted.
What’s going on?
Well, for one thing, pricing got really extreme on the downside. Then, when we weren’t looking at economic data and just hoping the economy would re-open, markets got really optimistic this thing would be over as fast as it started.
Now reality is starting to set in. While we will most certainly survive this event, there is no certainty as to how long it will last. Schools are closed and going to remote-learning models for the remainder of the year. Governments are already committing to ‘stay home, stay safe’ orders extending through May. Unemployment is skyrocketing. Consumer behaviors are shifting as the necessity of capital preservation becomes reality.
This week we’ll also watch the fixed income markets closely. The government has played a dangerous game by all but encouraging people to skip rent, mortgage, and utility payments. For those individuals, it may help with cash flow, but the repercussions to the banking system may be significant.
What does all of this mean? Pricing insecurity. How do we know how much a bank stock is worth if we don’t know whether or not its loan portfolio is stable? And even if the Fed backstops all the banks (which I suspect they will), how does the market price interest rates when payment on loans is inconsistent? If the loan hasn’t defaulted, but it’s not getting paid, how does one value the assets?
This is the world we live in right now. A world where economic rules are being tested, broken, or re-written on a near-daily basis. So sure, we can be optimistic that we’ll beat this virus… and we will… but between now and then, how does the market figure this out?
It’s hard to understand this rally as more than a technical bounce because of over-sold market conditions. When looking at the bigger picture of earnings and price stability, this market seems to be out over its skis and looking for a possible tumble.
Last week was a big week. We’re at the start of a new quarter. Rent payment for most tenants were due. So, we should start to get a sense of how the consumer is fairing very soon. The rest of the month we should start to see the market discussion shift from infections and death rates to more economic data. One concern is the medical data may be improving, but the economic data is failing. If so, the best-case scenario V-shaped recovery could be in danger.
As you continue to remain close to your family and calmly process the reality of this modern pandemic, feel free to call us with any questions about how we're positioned for this volatile time.
Kind regards, 
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April 14, 2020
