'Do you think there will be a retest?'
Advisors have been relating this question to me from their clients a lot in the last several weeks. “What should I tell them?” Human nature, which contributed to the March waterfall decline, has given way to “regret’’ for missing an historic bounce. All this has had me dusting off my behavioral finance presentation, which got so much play during the global financial crisis. It’s getting renewed interest today, as other advisors ask, “How can I get my shell-shocked boomers to stay invested?” The word “Japanification” has been creeping into my reading. March’s monthly decline in core CPI was the first in a decade and, with the economy on the cusp of what looks to be a deep but hopefully quick recession, UBS believes April CPI will fall the most in its 60-year history. No district in the Fed’s latest Beige Book survey—taken when widespread social distancing and stay-at-home orders were going into effect—reported wage pressures. Some (with the exception of high-demand sectors such as grocery stores) even mentioned pay cuts. Oil’s collapse is further evaporating price pressures, with the market viewing a voluntary production-cut agreement as lacking credibility, much less sustainability. With global demand so far below capacity, it’s difficult to see inflation picking up, despite historical evidence that suggests prices could potentially break out if stimulus continues to pile on after a crisis ends. Even before the virus, the Fed couldn’t hit its 2% price target nearly 11 years into an expansion. Now the worry is inflation expectations could slip further, creating a stubborn feedback loop.
These deflation concerns—along with rapid signs of market dysfunction—help explain the Fed’s “whatever it takes” response. Its balance sheet soared above $6 trillion this week, with trillions more in the pipeline. Evercore ISI believes such a post-virus-crisis response will prove necessary if businesses and households are to increase spending and take on new debt, rather than cut expenses, as the crisis subsides and we all start going about our business again. The former is needed to jumpstart the recovery; the latter would only prolong the pain. 10-year yields currently suggest perceived macro prospects over the next decade have gotten markedly worse. As for this year, there may be no such thing as earnings estimates, just guesses. Such was the case for much of 2008 and 1934, when Graham and Dodd published their classic “Security Analysis.” Looking at balance sheet quality and price-to-book ratios, Renaissance Macro suggests stocks are not as cheap as 2008. It expects the current earnings season to reflect this weakness but not enough to retest March’s lows as investors are looking to 2021’s anticipated rebound to value the market.
“Peak virus” doesn’t equate to “peak lockdown,” a concern as states and the White House debate when to restart. Potential pitfalls include the lack of market breadth, as was the case with last week’s 12% rally, the eighth best since 1929, and doubts about upsizing the payroll protection program (more below). On the other hand, Leuthold notes there have been only three bear markets since 1899 with interim rallies as large as this year’s, with the move off the March 23 low the best of all, giving bulls historical support. Also, last Thursday’s close above 2,800 represented a full 50% retracement of the decline, solidifying the view the bottom is in. However, the aftermath of such momentum surges is a lesson in patience. Forward returns over the next one to three months tend to be random and mean reverting, Strategas Research says, while performance six to 12 months out tends to be exceptional. The largest 1- to 3-month drawdowns after such rallies fall in the -10% to -15% range, implying 2,450-2,550 on the S&P 500, a good area of support and low enough to reintroduce mid-March’s apocalyptic thinking. Patience. The S&P also has reached 2,800-2,920, a gap representing the second leg down in early March, which TIS Group suggests needs to be filled. Patience, again. As much as the Silent Generation, the “Depression babies,’’ swore off “risky stocks,’’ millennials witnessing yet another global crisis and remarkable volatility see today’s market as a “casino.’’ Behavioral finance redux. Or as my once-boss likes to say, “You’ve got to be a psychologist in our business.’’
- Second derivative on jobs? More than 5 million initial jobless claims were filed last week, lifting total new claims to about 22 million, over eight times the worst 4-week period in the last 50+ years. This suggests April’s unemployment rate could spike to 17%, a post-WWII high. But the 5-million figure also was significantly below late March’s 6.8 million peak, indicating the worst of the layoff surge has passed.
- At this writing, the VIX is at 39 That’s down from its record closing high of 82.69 on March 16. Interestingly, during the global financial crisis, the VIX also spiked above 80, then fell below 38 after the March 2009 bottom, starting a trend lower as the cyclical bull got underway.
- Another source of market support Rapid money growth tends to push up asset prices, particularly if inflation is MIA, even in the face of discouraging economic news. In the U.S., the supply of readily available money (cash and money market savings but not bank CDs and other time deposits) has jumped 19% year-over-year to almost $19 trillion. And China’s money supply is up 10% to almost $30 trillion.
- There are a lot of small businesses It’s estimated the average loan requested under the payroll protection program was $125,000, indicating the program’s $350 billion that ran out on Thursday covered just under 3 million establishments. For context, an industry survey suggests a fifth of the nation’s 30 million small businesses can’t survive a 1-month interruption in revenue.
- Shout-out to dividends A San Francisco Fed study of 15 prior pandemics found lower real rates of return persisting thereafter. The study notes current valuations suggest 10-year annualized S&P price returns of 4-5%, roughly half their 8% post-World War II era average. If this be the case, aren’t dividends a bird in the hand?
- A lost source of market support Companies have suspended stock buyback programs of about $200 billion the past two weeks and, based on trends, 2020 buyback amounts could fall $500 billion. At their peak in 2019, share buybacks totaled about $800 billion, driven by Technology and Financial sectors that have also been the most prolific issuers of stock-based compensation over the years.
The strong get stronger Growth vs. value hit a new high this week and the Nasdaq 100 continued to outperform the S&P, reflecting the stability of market leadership during this crisis. Health Care and Technology remain sector leaders. Moreover, while about 20% of S&P companies are rated A, AA and AAA, they contribute half of 12-month forward earnings, meaning the collapse in A-rated yields will make those equities look attractive and command higher P/E multiples when the recovery comes.
There’s a place for value During the 1990s, as rates plummeted and after a 60% drop in 1990-92, the Nikkei 225 Index remained in a range for the remainder of the decade. Against this stagnant backdrop, Japanese value stocks (low P/E) led until 1999, dividend yield also outperformed and momentum lagged.
No depression this time! In the 1800s, a typical term for a sharp economic contraction was “panic,” though “depression” also was used. The 10-year duration of the downturn in the 1930s required a different language, and the term “Great Depression” was used. After that, “recession” was used to indicate a cyclical downturn that wasn’t as steep or prolonged as the 1930s.