Summary
- This recession will not be short, nor shallow.
- The impacts of COVID-19 will be permanent and far reaching.
- Changes that were going to take place over a couple decades, will now take place over a few years.
- It is very unlikely that the stock market or debt markets have bottomed yet.
- We should continue to sell the rips and wait for a bottoming signal.
This week’s (no so) quick take will take a look into the state of the stock market and economy now.
A Deep Recession
At the end of 2019, the economy was already cresting and showing signs of weakness in indicators. Economic indicators, like PMI and jobs growth were both falling. Other indicators were either peaking or already starting to turn over.
Despite that, we were not likely to see a recession in 2020. A slowdown to below 2-3% trend growth was all but assured, but not an outright recession. Prior to coronavirus COVID-19 crisis the economy was projecting out at 1% to 2% GDP growth in 2020.
The human and economic shock of the coronavirus crisis sent us into recession almost immediately after declaration of a national emergency. I believe this is the first time we can pin the start of a recession to a day. This “coronavirus recession began” on Monday, March 9th, 2020.
We should not expect this recession to be short or shallow. We are going to see some of the worst GDP numbers in history in March and in Q2 of this year. Even with a massive bailout bill, we should not expect to return to trend growth above 2% for about a year.
The bailouts will not have the same impact as 2008-09. That was a cyclical slowdown in many respects. This recession is a cyclical slowdown in a structurally weak economy, i.e. “slow growth forever” that has been hit with the absolute largest negative economic event in history.
This recession is a cyclical slowdown, in a structurally weak economy, i.e. “slow growth forever,” that has been hit with the absolute largest negative economic event in history.
Ongoing Impact Of COVID-19
The knock on impact of coronavirus will be many fold.
We will see a permanent change in how people work. Corporations across America are going to make a wholesale move to having people work from home far more often. It will become common for people to work from home 2 or 3 days per week.
Why will companies embrace work from home? It will be a combination of two reasons. First, we will prove that we can work effectively from home. Orders from the executive level will override the wishes of fiefdom loving, shoulder hovering middle managers. It will be the highest ups who decide that working form home is desirable.
Corporations will also move towards “more work from home” models as a way to contain future health costs. We know, that there is another virus coming someday. “Disease X” as it is referred to will be a disease more virulent that COVID-19 and more deadly. What we are seeing today is a dry run for when it happens. It is not an “if” it happens situation.
With more people working from home, the demand for oil will stop growing imminently, likely within 5 or 6 years. This coincides with regulatory rules driving the introduction of primarily EV fleets by all major auto manufacturers.
Office rents will fall dramatically and not recover until buildings transition to multi-use formats. We should be very wary of not only retail REITs that are getting “Amazoned,” but office REITs that will have to spend a lot of money converting buildings to part residential, part office and part retail & restaurant.
How we entertain ourselves will also change. Airplanes will see reduced seat counts, increasing airfare. Stores will have wider aisles. Restaurants will have more space between tables. The list goes on and on.
Current Market Conditions
Our benchmarks for the stock market are the S&P 500 and Nasdaq 100.
The SPDR S&P 500 ETF (SPY) is examined as a benchmark for measuring performance relative to less sophisticated investors.
It is widely expected that earnings plunge in the April and July reporting periods. I agree. I also expect the bars to be set extremely low by executives in April. This will be the “kitchen sink” quarter where expectations are dramatically reduced.
As April progresses, I also unfortunately expect a surge in infections and deaths from coronavirus COVI-19. This will dash any hopes of a quick “return to normal” in the economy and nation as a whole. Combined with the lowered profit expectations, I am looking for a bottom in stocks sometime in April or May. I continue to believe that the S&P 500 will bottom around 1700.
Here is where the S&P 500 stands today on the daily, weekly and monthly charts:
When all three are simultaneously oversold on the daily, weekly and monthly charts, that will be the optimum buying opportunity. The same can be said for our preferred large cap index, the NASDAQ 100, represented by the Invesco QQQ ETF (QQQ)
A Quick Thought On Valuations
As of right now, the stock market has still not come down to a historically normal level for expected (hopeful) 2021 earnings. The stock market, even after a dramatic plunge, is still overvalued.
Let’s take a look at corporate earnings going back a couple decades. Annual earnings for this year, pre-coronavirus, looked to be about $140 annualized for the S&P 500. I think we will be lucky to see $70 this year and $120 next year. And, I’m not so sure these aren’t optimistic assumptions.
Discounting this year and looking at next year, if earnings come in at $120 and we assign a fair price to earnings multiple of 16, then the S&P 500 fair value is $1920.
Even at $140 of earnings per share and a multiple of 20 (historically high representing strong growth), fair value is 2800. This would of course move the S&P 500 into overvalued territory once again.
With coming dividend cuts coming to likely around 100 companies in S&P 500 what should we expect for the rebound prospects for those companies? Not much I believe. Those companies have little growth and high debt. Tough hurdles to overcome. It should be easier to understand why I have said the S&P 500 may show no gains for the 2020s other than dividends, or about 2% to 2.5% annualized.
The companies in the NASDAQ 100 hold about 70% of all cash on corporate balance sheets. These stocks are all in the S&P 500. They have more growth, less capital intensive businesses and generally on the right side of the massive secular trends. When the time comes, QQQ is the large cap index to own. If we want other stocks from the S&P 500, and we do, we will cherry pick them.
Don’t Despair, Repair
The 2020s are going to be a lot like the 2000s. We know that going in. Others don’t, but we do. And, even if we’re wrong, that doesn’t matter, we are still better prepared for whatever develops.
I have a grasp of the economics and those I follow are far smarter than me. America will come out of this stronger, but with new scars. These will be the stories that are told about the coronavirus crash and recession.
Someday soon, but not too soon, we will also have to deal with the retirement system at the brink of collapse. Again, we know it’s coming, so we can prepare. We can make money in between. And, we will become defensive quicker than most when that happens too.
In coming months, we will look to move our investments into the “smart everything” and alternative energy worlds. We will add some gold and resources as well to protect against scarcity. In the meantime, take of yourselves and be kind to people who have it tougher.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
