Have We Seen the Low?

Advertisement

Stocks have been rallying hard. Is the worst behind us?

In Lords of Finance, Liaquat Ahamed writes that shortly after the stock market crashed in 1929, President Hoover promised Americans that things were “back to normal.”

By March of 1930 (about five months later), Hoover claimed the high-point of the crisis would be over “during the next 60 days.”

After those 60 days, he announced “We have passed the worst.”

Ahamed writes that, eventually, “when the facts refused to obey Hoover’s forecasts, he started to make them up.”

But those made-up facts couldn’t stop The Great Depression.


***Today, we’ve seen the U.S. government minimize the potential impact of COVID-19

 

From Trump, back on February 10:

Now, the virus that we’re talking about having to do — you know, a lot of people think that goes away in April with the heat — as the heat comes in. Typically, that will go away in April. We’re in great shape though. We have 12 cases — 11 cases, and many of them are in good shape now.

Then there was the call that we’d have the economy re-opened by Easter, which we now know won’t happen.

Most recently, Trump has said there’s “tremendous light at the end of the tunnel,” and we’ve learned he’s looking at how to reopen parts of the economy, beginning with smaller cities that haven’t been hit as bad, before eventually moving to larger, affected cities like New York and Detroit … even though some health care professionals believe this to be premature.

Now, though the parallels between Hoover and Trump are interesting — and possibly disconcerting — we’re not suggesting the takeaway is that the U.S. economy is teetering on the edge of another depression.

The reality is we simply don’t know what’s next … whether good or bad.

However, if you look at the recent surge in the stock market, as well as many headlines claiming we’re at, or nearing, peak COVID-19 cases, you might get the idea that we’re about to move past this crisis, and life (and the stock market) may soon return to mid-February conditions.

That could be a dangerous idea.

In today’s Digest, while cheering the recent market surge, and while hoping for a quick end to this crisis, let’s consider the other side.

Specifically, let’s look at the case for what might be a slower recovery … more downside in the investment markets … and a drawn-out fight against COVID-19.

We’ll do this to prepare ourselves as investors. Everyone wants a fast recovery. But we need to have the right mindset if it turns into a lengthy recovery.

In fact, through a change in perspective, we can see any prolonged market weakness as a wonderful, long-term opportunity. Not only will we get through this, we have the chance to get through this with stronger, sturdier portfolios that will reward us for years to come.

So, today, let’s map this out — hoping for the best, but preparing for the worst.


***What does the stock market really do?

 

At the end of the day, the stock market performs one primary task — it prices the value of a company’s assets and earnings power.

For example, what happens when Company A announces unexpectedly high earnings?

Well, the stock market recognizes that Company A is more valuable than before (hence the high earnings), and so money floods into Company A’s stock, pushing its price higher to accurately reflect its new, greater earnings power.

On the other hand, when Sector B is hit by tariffs, or perhaps an unexpected dry-up in demand, prices fall. That’s because Wall Street is now pricing in this new information, updating the sector’s decreased earnings power.

In both cases, what’s the key ingredient?

Information.

Now, since mid-February, the S&P has dropped 34%, then rallied 19% as of yesterday’s close.

This volatility has been a furious attempt from investors to price-in the economic impact of COVID-19.

But based on what information?

Hold on to that …

As I write, there’s a growing sense of optimism in the air today — again, we’re up 19% from recent lows, hearing talk of slowing COVID-19 growth, and discussing reopening the economy.

I’ve seen financial talking-heads speak of a V-shaped recovery, more still are claiming we’ve already passed the low of this bear, and recently, one fund manager even suggested that markets are rallying because investors have now priced in all the bad news.

A question …

***How in the world can anyone say we’ve priced in all the bad news (or seen a bottom for that matter) when we don’t even begin to have all the “news” that might be bad?

 

For the stock market to price stocks with relative accuracy, it needs information. But consider the vast expanse of unknowns spread out before us today …

Though COVID-19 cases are reportedly slowing in certain locations in the U.S. (and around the world), when will they drop low enough for governments to greenlight people venturing out again? What does “low enough” even mean?

How long will the reopening rollout last? A month? Eight months?

Even after the “reopen,” will many American consumers be too worried to immediately head back out?

What if we reopen too soon and it leads to a fresh uptick in new cases? (This has happened in Singapore, Hong Kong, South Korea, and Taiwan, as travelers from the U.S. and Europe have reimported the virus.)

What will “normal” be after the smoke clears? Will some sort of social-distancing guidelines remain in place for a period of months, therein limiting how many people can be in, say, a Starbucks at once?

When will people feel comfortable flying again? Or taking a cruise? Or packing into the local bar?

Here’s a nasty one — even if COVID-19 cases drop over the next several months, will they come back in the fall as did the Spanish Influenza? The second wave of the Spanish Flu (which came in the fall, after the first wave hit earlier that spring) was actually deadlier than the first. It killed 195,000 Americans in October of 1918 — that was 28% of the total of 675,000 American deaths.

There are plenty more questions, but let’s jump to the punchline for us investors …

“Earnings” is the bottom-line number that drives stock-market prices. So, how will all the aforementioned unknowns affect corporate earnings?

That’s the biggest unknown of all.

So, this fund manager claims we’ve priced in all the bad news?

We don’t even know what the bad news is yet.


***Can we learn anything by looking at past bear markets?

 

Going back to 1928, the average percentage decline of the 20 bear markets we’ve seen has been 37%, with the average length being 12 months.

The more severe bears decline about 45% and last roughly 15 months.

Of course, these bears are never “straight down.” They often come with attempted rallies that, in retrospect, give way to fresh lows.

Take the head-fake rally we saw in the 2008/2009 bear.

Below, you can see the S&P “bottoming” in November 2008, rallying through early January 2009, only to then fall to its ultimate low in March.

 

 

This head-fake rally lasted roughly six weeks and saw a gain of 24%.

Now, do you think this rally instilled some optimism in investors and the financial media in a way similar to what we’re seeing today?

Spoiler — it did.

In fact, below is a CNN Money headline from December 8, 2008 … the S&P had another 23% drop in front of it before hitting its final low.

 

 

Let’s also remember that from our February all-time highs through today, it’s been less than two months. As we just wrote, the average length of a bear market is 12 months.

Given all this, and considering we haven’t seen Q1 earnings yet — which, keep in mind, won’t reflect the full damage of COVID-19 since they’ll include 1.5 months of “business as usual” — how confident are you we’ve seen the low? Or that we’re on the verge of bouncing back to February levels in short order?

 

***”But Jeff, past bear markets don’t really apply because this is a unique, Black Swan bear market. Our economy was fundamentally strong beforehand, so we’ll have a vigorous recovery once COVID-19 passes.”

 

First, I hope that’s true. But as thoughtful investors, let’s challenge the logic.

If I break my leg, the amount of time it takes for me to get back on my feet isn’t so much impacted by how strong my bone was yesterday, but by the severity of the break today.

Is it a small hairline fracture or a massive compound fracture?

The time to recovery is also affected by how quickly my body can heal, which is in part impacted by whether I’m staying off the leg or trying to walk on it. Again, this has nothing to do with how strong my bone was yesterday.

Consumer spending makes up about 70% of GDP in western economies.

Last week, 6.6 million Americans filed new claims for unemployment benefits. That pushes the two-week total to 10 million. For context, that’s more than the combined populations of Los Angeles and Chicago … now unemployed … and therefore, mostly not spending money.

That’s a massive compound fracture for our economy.

And what happens if COVID-19 migrates from hot-spot to hot-spot, jumping borders, going away, coming back, requiring social distancing that impacts retail earnings, and so on?

That would be like trying to walk on the broken leg too soon, slowing down the healing process.

I’m not calling into question whether we’ll recover from this — we will. But I am calling into question whether we’ll race back to mid-February strength as fast as some believe.


***The big question for investors is how will COVID-19 impact corporate bottom lines — and for how long

 

Given that 70% of our GDP comes from consumer spending, the answer depends on when consumers will have money to spend — and feel comfortable spending it. So, when is that?

We don’t know. It depends on when most of the currently-unemployed people will have jobs again, and when everyone can venture out to spend their incomes. So, when is that?

We don’t know. It depends on when COVID-19 is “contained enough” (whatever that means) for our economy to reopen without new hot-spots forming. So, when is that?

We don’t know. That depends on how well the nation practices social distancing, gets tested, and contains new hot spots as restrictions ease. So, when is —

You get the point.

Actually, on that last point, “testing” is a huge variable. We need lots of it. So, what’s the time-frame there?

From The Wall Street Journal:

Testing is hampered by delays and shortages that limit who can get tested. It is unlikely that the problems will be resolved by the end of April, according to one person familiar with the planning.

Some health experts said any reopening scenario is likely to work like an accordion: Any easing on social distance protocols would be followed by a tightening in areas where the virus resurfaces. A vaccine is still at least 12 to 18 months away, and even that timetable is considered optimistic.

And this brings us back to all the “unknowns” in front of us.


***The market volatility we’ve seen so far is Wall Street blindly flailing about, trying to price in “bad news” prior to even receiving the bad news

 

It’s like noticing your cat walk into the adjacent room then hearing a crashing noise.

You race in to see what the cat knocked over, but the room is pitch black.

Did the cat tip over a $3 trinket? Or a $1,200 vase?

This is where the market is today. And it’s only over the coming weeks and months that we’ll be able to turn up the dimmer in the pitch-black room to reveal the true nature of the damage.

Now, is it possible that light will reveal that stocks have already fallen enough to accurately reflect COVID-19-impacted earnings? Or even that stocks have fallen too far based on where earnings come in?

That’s the hope.

But is it also possible that earnings are in worse shape than expected? And that COVID-19 will linger, slowing our economic recovery deep into 2020? Could that mean we’re in for six-to-ten more months of a bear market, and another 30% pullback?

Yes.

I’m not saying this will happen. But this is what we have to be mentally prepared for as investors.

But now, let’s brighten the mood …


***Despite everything written above, we’re incredibly bullish for the long-term, and believe our current market is creating the right conditions for massive wealth creation

 

Even though the answer to “when?” lingers, this crisis will pass.

In the meantime, in the weeks ahead, we may be presented with the best buying conditions many of us will ever see in our lifetimes.

If markets retest lows, or even fall lower, not only won’t that be the end of the world, it would be an extraordinary opportunity. We could have the chance to buy world-class companies at generational lows. Premier assets that will create wealth not only for you, but for your kids — possibly their kids.

Now is a time for excitement. For building a portfolio shopping list. For creating a “fantasy team” of elite investments.

We’ll help you with this here in the Digest. Over the coming months, if markets turn south, we’ll be profiling certain sectors, helping you identify the best-of-breed stocks in each one.

But underpinning that will be our collective responsibility to view any market weakness for what it is …

Opportunity.

So, today, let’s toast the recent market surge. With any luck, we have, in fact, already passed the low-point of this bear.

But if not, if the upcoming earnings season and beyond brings challenging days, be mentally prepared. It will actually be our chance to create world-class portfolios.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2020/04/have-we-seen-the-low/.

©2024 InvestorPlace Media, LLC