You could be forgiven in thinking that the last quarter felt like one of the longest three months of your life. In what now seems an eternity ago, it could be hard to forget that the S&P 500 enjoyed a total return of more than 30% in 2019. What has not been so easy to forget, for bulls and bears alike, has been the violence of the moves, both up and down, in the markets. There has never been a bear market associated with a recession that lasted only four weeks. Then again, there has never been a period in which the awesome economic power of the federal government and the central bank have been brought to bear so quickly.
Why does the stock market seem so detached from our current reality? This is a question that we continue to ponder repeatedly, and if you have been wondering the same thing, you are not along. To review, U.S. stocks fell 34% from its February 19th high as the first known cases of COVID-19 began to pop up beyond China’s borders. U.S. stocks bottomed on March 23, and rebounded as high as 45% by early June, even turning positive for the year.
So, how best to explain the stock market rally? Well, its…complicated. This year has brought to light a number of questions that are not accompanied by a simple answer. Our preference as humans is for simple and orderly. However, answers are often complex and require multiple explanations.
The market has been unbelievably resilient, as stocks continue to surge despite the continued acceleration in coronavirus cases. And while the market isn’t priced for perfection at these levels, it feels like it is priced for a lot of macro unknowns turning out positively.
Given the current situation, if you are a bull, here is what you might be assuming:
- That the economic stimulus is extended in an amount close to current levels. In aggregate, that means the July stimulus bill will be close to, or over, $2 trillion. Getting more granular, the key is what happens to those $600-week checks for the 14-million unemployed. To be aggressively buying stocks here, we think one must assume the weekly amount stays close to that level (say above $400/week) and is offset by some large one-time payment (another stimulus check). Is this likely, given what we know now? Our thoughts: First, it is an election year, so typical fiscal “responsibility” in Washington is even less constrained than usual. Additionally, given the surge in coronavirus cases lately, it is more likely than not, although Republicans appear adamant and curtailing the weekly payments. But while not a sure thing, if coronavirus cases stay large, the fifth stimulus bill probably clears $2T and the weekly payments don’t fall much.
- That the surge in coronavirus doesn’t result in too large of a delay in a return to economic normalcy. We assume that it’s very unlikely we get another national lockdown (or even large state lockdowns). So that’s an economic positive. Additionally, people have largely ignored the uptick in cases, because, as of yet, the surging numbers aren’t matching their personal experience. Hospitalizations are rising but not to the scary levels of March/April. Deaths are not rising nearly as fast as cases, i.e, the mortality rate is lower. Many new cases are asymptomatic. So, until we get another national lockdown or people begin to “self-lockdown” en masse, the bullish view is that it won’t materially delay an economic recovery, especially if there’s more stimulus.
- That the 2021 S&P 500 earnings stay above $160/share. Currently, the S&P 500 is trading above the 19x 2021 earnings. Even considering stimulus, we think that’s ultra-aggressive considering the downside risk if 1) Stimulus disappoints or 2) Coronavirus causes another lockdown (forced or voluntary). So, the next few weeks of July, the heart of earnings season, will give us an exceptionally good idea of that >$160 expectation for 2021 is still reasonable. If it is not, that will be a material headwind on stocks, regardless of stimulus or coronavirus.
Bottom line, we will know a lot more about the outlook for this market in the next three weeks as we’ll learn: 1) If the stimulus bill will be big enough to satisfy the market, 2) If hospitalizations and deaths rise enough to delay any economic recovery, and 3) Whether the >$160/share 2021 S&P 500 EPS expectation is realistic.
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