| COVID-19 Crisis – Week Ending May 15, 2020 How can stocks be trading at current levels when the economic data is so abysmal? That is the theme for this week and it is a fair question when looking at the data: GDP is expected to contract between 4 and 6 percent this year, and near-term unemployment rates may attain a level of 17%, a level not seen since the Great Depression. When you consider how much economic value will be lost from GDP contraction (what we define as a recession), the reality is quite staggering. A 5% contraction would result in an estimated $1.1 trillion in reduced GDP. In order to offset this, the Federal Government has provided about $2.7 trillion in direct support to households and businesses through the CARES Act and other programs. The offset to the loss ratio is 2.45 to 1. This does not include the additional monetary support provided to companies and municipalities by the Fed, which is now in excess of $6 trillion. In total, the combination of fiscal and monetary stimulus represents approximately 40% of GDP, or about $8 of stimulus for every dollar loss of GDP. Even with this offset ratio, the concern remains regarding how much dislocation will occur in the process due to business bankruptcies and unemployment. In other words, what job losses will be made permanent? If we accept that a large portion of the April layoffs were indeed temporary, then we should see those jobs come back relatively quickly. The Bureau of Labor Statistics in a recent survey found that 78% of respondents believe their job loss is temporary.[1] If we find that there is more structural damage from the shutdown, then this could prolong the recovery both in the economy and in corporate profits. It is forecast that 94% of the country will begin to emerge from shut-down by Memorial Day and each day that businesses are able to get back up and running will mitigate this permanent loss. But what about the path of virus and the effect this will have on consumption? Clearly, certain areas of the economy will lag as we come out of this. We don’t anticipate travel and leisure industries to rebound immediately. Restaurants, bars and theaters, for example, will only slowly come back due to social-distancing restrictions. We are watching closely as states such as Georgia, Texas and others re-open to get a gauge of these areas. For other sectors, it will depend on the speed and resumption of consumer activity, and if the housing market is any indication, a recovery is already clearly underway.[2] Finally, and as the Wall Street Journal recently noted, price to earnings measures only get you so far, but they do provide some guidance.[3] Strategas (a Baird company) forecasts that earnings on the S&P 500 could be around $110 by year-end, approximately a 31% decline since year-end 2019. Applying a simple price to earnings (P/E) ratio of 18 would suggest a level on the S&P 500 of just under 2000. The S&P in March bottomed around this level, suggesting that the damage to corporate profits was realized and priced in at the bottom end of the cycle. As markets undergo recoveries they tend to look out six months to a year. [4] Today the S&P is at 2,820. The Street consensus is that earnings will recover by the end of 2021 at around $170, and again, applying an 18 P/E multiple would have the S&P 500 pricing at 3060, still well below where the market peaked in February of this year at 3409.[5] Furthermore, as we noted last week, it’s been a lopsided recovery with a handful of very large tech stocks driving much of the recovery in the S&P 500 index. If we priced the S&P 500 on an equally weighted basis (where every stock in the index receives equal treatment, and not based on how the large the company is), the index would be down below 20%, still in technical bear market territory. This is why having proper positioning in the portfolio will be very important as we lead into the recovery, regardless of the path or speed. |
