The markets may have entered the acceptance phase of the three-stage grief process (shock-awareness-acceptance). There is more clarity on the coronavirus crisis’s health and economic effects and, importantly - from the market’s perspective – on what policymakers’ response will be going forward.
The shock phase of the crisis - and the speed and severity of the market decline (-34% in 33 days) - shifted to the awareness phase as the outlines of the economic damage and policymakers’ response emerged, spurring the market to discount the eventual recovery. Whether a V, swoosh, or U-shaped recovery was less important than the massive stimulus that was applied.
Between $10 and $11 trillion, roughly 45% of GDP, in stimulus was enacted. This is 2.5x what was spent in the financial crisis.
Acceleration in hiring and spending, as indicated by high frequency economic data, has happened sooner than expected.
The S&P 500 has rebounded 42% from its March 23rd low and is valued at a P/E of 21x forward earnings. There is a dramatic dichotomy between the real economy (“Main St.”) and the equity market (“Wall St.”), but the rationale has been that the market is a discounting mechanism and rate of change of data is most important.
Acceptance phase marked by the understanding that:
The Federal Reserve will do whatever it takes to keep economic momentum going and asset markets supported. In mid-June, it began purchasing individual corporate bonds in the secondary market according to a market index that it created.
Fiscal authorities are contemplating additional stimulus – the Heroes Act, which was passed by the House in May, would provide $3 trillion and extend unemployment benefits of $600/week through start of 2021. News reports say the White House is working on its own stimulus package.
Health authorities’ response will include increased testing, contact tracing, local lockdowns and phased re-openings, as needed. There is acknowledgement that the virus will be with us for some time, but the political will to enact additional national lockdowns appears absent. Rolling regional shutdowns and/or sheltering of vulnerable populations most likely.
The June 8-10 Federal Reserve Meeting may have been an inflection point for the Main St. vs Wall St. dichotomy
The Fed’s dour economic forecast (interest rates at zero through 2022) and the remarkable comment about “not thinking about raising rates” spooked the markets. The bond market supports this view: The 10-yr US Treasury bond currently pays 0.68%.
Cyclical, value, and small cap stocks started to underperform on June 8th.
Typically, S&P 500 discounts 6-9 months out. Is currently discounting 2021-2022 recovery. Significant risks with little room for error at current valuation and little corporate earnings visibility. Prospects of a slower economic rebound with valuations in top 10% historically is a poor risk/reward trade-off.
At a P/E of 37x forward earnings, The NASDAQ is now officially more expensive than in the 2000 tech bubble.
