The recent stock market rebound from the low points in March has cheered investors after the terrifying plunges that took stocks from record highs to bear market at a record pace. It seems like everyone is forecasting a fairly quick return to normality and investors have been ‘looking past’ the economic pain to the recovery. The rebound in the S&P500, for example, means the the market is just three percent lower than it was a year ago and 14 percent down from the start of the year.
Let’s put this in context and think back to the start of the year. Regular readers of the RMWM News Round-up will be aware that all the signs associated with stock market peaks were there. Economic growth in several countries was on the verge of recession and had slowed sharply in the US. American stocks were trading on, or close to, record high valuations (price/sales, Enteprise Value/EBITDA, price relative to earnings growth, stock market cap/GDP etc) and these valuations were being supressed by the massive stock buybacks companies were carrying out.
The 14 percent drop in price since January is so small that company valuations would still be above their long term average, even if there had been no coronavirus. However, it is becoming clear from the emerging data that the coronavirus has delivered the deepest economic shock in history, the impact on corporate results will be worse than during the financial crisis and companies have been cutting buybacks and dividends at the fastest pace on record.
The fall in stock markets to date would have only brought company valuations down to more reasonable levels if earnings had held up. As it is, earnings are likely to be decimated for one or two quarters at best, and for much longer if people are slow to return to their former spending habits (including eating out, travel etc), if they are out of work or if companies start to go bust in significant numbers.
So far, the effect on unemployment has been stunning, with the US seeing about 16 million people (over 10 percent of the workforce) claim unemployment benefits in just three weeks. The extent of government support that has been promised has also been staggering, which ought to underline the severity of the crisis.
Whilst the future is very hard to predict, it currently looks like the stock market has not even begun to price in the economic impact of the coronavirus, it has simply had some of the froth taken out of it. Possibly due to the relative inexperience of traders working in financial markets, many of whom have never experienced a proper bear market during their career, markets appear to believe that the world as we knew it still exists, that this is simply an opportunity to buy the dip. They have yet to factor in the impact of a kick in the teeth that is beginning to look like the worst economic downturn in history.
Finally, it is also worth mentioning that the range of bailouts now covers most risky aspects of lending markets – central banks or governments are guaranteeing or bailing out junk bonds, real estate debt, mortgage payments, leveraged loans, doorstep lending and even auto financing. This all comes in addition to paying the wages of tens of millions of employees. The attempt to fight the natural economic cycle is staggering in its scope, it is totally without precedent. Will it work? No one can possibly know yet. We are going to find out if there is such a thing as a free lunch after all.
Richard McCreery is an investment adviser with over 20 years experience, based in the South of France. www.rmwm.jimdo.comRegulated in France by the Association Nationale des Conseils Financiers (ANACOFI), registration N° E004136. ORIAS member 13000050