Markets rebounded impressively in April, posting one of their best months ever. This rebound off the March lows was able to recover a good portion of the year’s losses, but are we really out of the danger zone? This is a very unique situation as we have a complete lack of fundamentals on which to value companies.
No one knows the exact timing of reopening the economy and how it will play out. It’s never been done before. As such, companies can be forgiven for providing little or no guidance. Earnings season has been more focused on balance sheets to determine which firms have the best staying power and which can outlast the competition.
As a gauge in the dramatic change in estimated earnings, let’s look at the S&P500. In 2019, earnings per share for the index were $150. Expectations for 2020 at the start the of year were around $165. But in the last month, given the virus and resulting shutdown, estimates now range from a low of $90 to $130.
If we take $100, that is over a 30% drop in earnings expectations in one year. If we then look at a situation with the economy in a V-shaped recovery, resulting in 30% growth for the next two years, we get 2021 at $130 and 2022 over $160 (yes, back to what we should have done this year). That is an optimistic scenario, but it still shows more than two lost years.
The next big risks for the market will be late summer and the fall. Everyone is focused currently on when the economy will reopen and most expect a rapid recovery. But what happens if they open and no one shows up? As Yogi Berra once said, ‘if the people don’t want to come out to the ballpark, nobody is going to stop them.’
With so much of the economy shutdown for an extended period and many adjusting to work from home models, there is a very real possibility that the new world won’t be like the old. Even worse, not everyone will be rehired into their old roles. This will take time and no one should expect an instantaneous return to ‘normal.’
Given the lack of fundamentals, technical analysis has played a huge role in this recovery and the biggest debate is ‘to retest, or not to retest?’ In most dramatic sell-offs, you get a sharp rebound (like we saw in early April) but then get a low volume sell-off towards the previous low levels. This was the case in 2008/09.
One of the more notable exceptions to the trend is the December 2018 sell-off in which the levels weren’t seen again until only a few weeks ago. What is different this time has been very aggressive and proactive actions by global central banks. Well over $2-trillion of stimulus was enough to offset the first wave of the economic collapse. The direct buying of fixed income ETFs in the market was unprecedented. It’s notable that this is one of the first times central banks have begun easing programs before a recession started.
This begs the question, are central banks out of bullets now? The next and potentially last step for central banks is the direct buying of equities. Who wants to bet against that in an election year? Fiscal programs will be relied upon to avoid that scenario and act as support to bridge the gap for many businesses. However, the length and amount are still unknown.
Given the amount of stimulus, is it any wonder one of the best performing assets this year has been that classic insurance policy of gold?
Everyone should be impressed with the market response in the past month and we hope the economy can survive the shock. We still expect volatility to be the new normal and would look towards the bond market to signal a resumption of normalization in the broader economy. The shutdown and social distancing measures are working. Let’s hope we stay the course to see them through and can start the process of getting back to normal.
— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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