Capital 19 Catch-Up

Matthew and Paul debate where the market goes next

What a crazy time we are living in. If you had told me six months ago that by March 2020 almost the entire globe would be locked down at home, unable to venture outside other than for essentials, I would have told you you were talking nonsense. Considering it has been more than 100 years since the last similar event (the Spanish flu in 1918 which killed an estimated 20 million to 50 million) it has come entirely out of the blue. The ultimate black swan event.

The stock market has been even crazier, with markets experiencing their fastest fall into a bear market in history, and swings not seen since the Great Depression of the 1930s. Now all of a sudden the major indices have rallied hard, the Dow is up 33% from March, while the benchmark S&P500 is up 30% over the same period. All of this while the US death toll is rising by thousands each day.

It has prompted a “lot” of discussion in the Capital 19 office – or in the Zoom strategy meetings from our home bunkers at least. There are two schools of thought on where we go next here. One says we have seen the market bottom and the major indices are on their way back to all-time highs by the end of the year. The other says that the worst is yet to come, and we’ll more likely than not retest the lows we saw at the end of March.

So instead of the usual Catch Up today we’ve split into two camps and we’re going to give you both points of view. The one that says the market is going to be fine from here on in, and the correct one. You can then make up your own minds and adjust your trading accordingly.

If you haven’t been able to deduce already, I’m perched firmly on the negative or, as I prefer to call it, the realistic side. There’s no doubt the markets have proved me wrong so far. I didn’t expect them to bounce back so quickly and with such force. It’s been nothing short of astonishing. But I don’t think it will last.

Think about some of the data results we have seen come in over the last few weeks. As of last Thursday, more than 22.025 million Americans have lost their jobs. Since the end of the GFC in November 2009, the US economy has added 22.442 million jobs. That means in just one more week the US will have lost all jobs gained since the last recession, which was well over a decade ago. All in the space of three weeks.

March retail sales were down 8.7%. That’s the biggest decline seen since the figures started being recorded in 1992. The New York manufacturing index for March slid to all-time lows as well, contracting by 78.2%. Bear in mind that during the GFC the worst it managed was a decline of 34.3%. Now, keep in mind that the shutdowns only started happening halfway through the month. In the first half of the month it was business as usual. That’s how bad the situation is right now.

The IMF has predicted that the global economy will contract by 3% in 2020. It was only back in January they were predicting 3.4% growth. How quickly things have changed. They also predict the US economy will contract by 5.9%, and the Eurozone by 7.5%. And these numbers rely on the assumption that the impact of the covid19 epidemic will ease throughout the year.

They’re anticipating that this will be the worst recession the US has seen since the Great Depression. That’s right, worse than during the GFC when the markets fell by more than 50% over an 18 month period. Even Goldman Sachs analysts are saying the current downturn will be 3-4 times worse than 2008-09. May I remind you that the S&P500 is currently only 15% off of all-time highs!

It’s all very sobering and the actions of the US Federal Government are hardly filling me with the sense of calmness and composure that I would expect at such a time. There seems to be somewhat of a gung-ho attitude to re-opening the states while ignoring medical advice. A move that could see the economy being shut down for even longer than is necessary.

Unfortunately, being an election year, all decisions are being framed around getting the President re-elected. And that means getting the economy re-opened as quickly as possible. Nevermind that going to too early will boost the rate of infections and deaths and mean the last month of hibernating has all been for nothing.

Of course, the stock market loves the tough talk of re-opening. Obviously, the quicker the economy is opened the quicker things will get back to normal – assuming that the rate of infections doesn’t rise again of course. Unfortunately doing it right now is just not based on the medical reality – or any common sense that I can make out. Coming out of isolation will mean many more deaths and a glut of civil disruptions. If you’re willing to cop millions of people dying so that the economy isn’t as badly affected then fair enough. But I suspect most US citizens would prefer to wait it out at home.

In the end, it will be up to the individual governors about when each state will open. And even then it will be up to the public to decide for themselves when they reemerge from their lounge rooms. It will be haphazard, lengthy, and a complete mess. The President has said the US won’t lose more than 65,000 people to covid19. In my estimates, they should reach that number in just a few weeks. With the eventual toll being many more.

There’s only one caveat to all of this, however. And that’s somebody somewhere finding a cure or treatment. Now, from what I’ve read a cure is at the very least a good year away. Finding a treatment, however, sounds like the most likely option. One which diminishes the deadliness of the virus and allows us to get back to something resembling a normal life.

This is the only thing that “should” get the markets moving higher because it will be the only thing that will get the economy going again. The timing of finding a treatment comes down to luck, and even if one is found tomorrow it still will need to be tested before it can be released into the general public.

Without a treatment, the US will have to wait it out at home until the virus dies out of its own accord. Different states may be able to open before others if they can block themselves from other states, while global travel could be more than a year away. The airlines will have to wait it out longer than most.

I’ll remind you again. The S&P500 is currently just 15% off of all-time highs. If by some fluke we manage to discover a treatment in the next few weeks and that gets delivered to patients within the next month or two I reckon we are just about at true market value at the current levels – given what the shutdown has already done to the economy.

The more likely outcome is that this will take months at best and there will be a lot more pain to come for both the economy and the stock market. It would not surprise me in the slightest to see new lows set in the near future. I hope to goodness I am wrong, but I won’t be risking my portfolio on the chances that it will all work out fine.

The recent bounce seems to me to be the perfect opportunity to do a stocktake. Keep your stocks that have performed well before the bounce, i.e your Amazons and Walmarts etc, while jettisoning any others that performed badly. They won’t hold up well if the market turns again. Hedging your portfolio, whether it be through ETF’s, futures or options would also be a smart move. Speak to your advisor if you would like some advice with this.

Alternatively, you could listen to Matthew who is about to tell you why the market is going higher from here and why you should load up on stocks. Good luck everyone.

Thank you Paul. Now, let’s hear from Matthew

Long term readers of our ramblings will know that Paul and I rarely agree on anything. We have been working together for over 20 years now and you would have thought that in all that time Paul would have learnt a thing or two and accepted that I am always right.

The problem Paul has with his view is he is not putting things into perspective. Oh yes, and that we have seen the bottom. That happened on March 23rd

The question we are asking is: what are stock prices going to do? Whilst the health risks will be around for some time to come, I am firmly of the belief we have seen the worst of the prices.

Stocks bottom on fear and uncertainty. Selling occurs in a panic. All you need to do is take a look at the action of the last 2 months and you will see we are through the worst of it. When the health risk news first came out, we saw wild market swings. Circuit breakers halting trading (what we call limit moves) occurred on a daily basis. That was caused by fear and uncertainty.

But consider what has happened since. The uncertainty is gone. Yes, we will have a recession. Yes, unemployment will be high. Yes, we could be in lockdown for months to come. Yes, certain industries will be hit hard. Yes, our way of life might change permanently.

Whilst this news does not sound good, it is now known. It has been factored into markets. The only thing that could cause a new low is for the economic impact to be greater than anyone expects, and with expectations already so negative it would take a very significant event to exceed them.

The other thing to bear in mind is the index is made up of 10 different industry groups. The impact will be felt differently by those different groups. The hardest hit areas are sectors like Energy (-64%), Consumer Discretionary, Industrials and Financials (down an average of 40%). The bad news has been factored into these sectors. I say it again. The bad news is already factored into stock prices. That is why certain sectors are down so much. We would need a lot more bad news to take stocks even lower.

But this environment gives an advantage to other sectors. Take technology. Amazon is at all time highs. Netflix is up over 40% this month alone. The Nasdaq is up 1.1% year to date.

When we talk about stock market moves and the index, we are not really talking about the average stock in the market, because each stock carries a weighting. Take the S&P500. Want to know what makes up over 17% of that index?

Microsoft, Apple, Amazon and Facebook.

That’s right those 4 tech giants make up 17% of the index. Those companies are not being badly affected by coronavirus at all. Whilst other industries are dragging the index down, their weighting is much less so they have much less of an impact.

This really is one of my big reasons as to why the indexes will not make new lows. Because the largest components of them are benefiting from the virus.

Then there is all the positive action by central banks around the world. They are throwing everything and the kitchen sink at it. The Fed is offering $3trillion in loans to keep the economy going. That is bigger than they threw at the GFC. The story is similar around the world.

When these funds hit the economy they work their way around and eventually end up sitting in the best performing asset. Which brings me to my next point.

You can talk about fair valuation of stock prices, but one of the inputs to that valuation is interest rates. Which are basically zero. So when the funds from the stimulus get released and go looking for a home, is it more attractive to put those funds to work in Amazon or in the bank to earn interest? Which of course will push the index higher.

To get the economy going again, we do not need a cure. We just need an effective treatment. On Friday we were told the Gilead drug remdesivir has shown promise in treating patients. We might even see as soon as tomorrow some American states relaxing lock down conditions as they start to take control of the spread.

It is easy to be fearful when you listen to the news. It is easy to think simply and say, this is bad that means stock prices will go down. But the correct way of thinking is that the bad news is factored in, we have positive news about drug treatments and already economies are moving toward starting up again.

In truth trying to time when to get into and out of the stock market never really works. That is why we advocate always staying invested. But you do need to rebalance your portfolios. Old industries like cruise lines and maybe restaurants will take a long time to recover, so cycle out of those and reposition into industries that will either benefit or recover faster. Our Pandemic Portfolio might be a good place to start.

My advice is to consider this the best buying opportunity for the next decade, maybe more. Do not let fear paralyse you. Buy good companies on every dip. Don’t be one of those people who look back in 12 months and wish they had taken action instead of waiting for even lower prices because they are not going to happen