July 4th Market Thoughts by Jim Newman

July 4th Market Thoughts by Jim Newman

July 07, 2020
  • 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.