This market has seen an unbelievable combination of headlines. We had bankrupt stocks skyrocketing which led to the headline that Chesapeake stock rose triple digits which was followed by the headline that it filed for bankruptcy. Similarly, the S&P 500 went positive on the year on the same day the NBER announced the economy peaked in February 2020 which means a recession started in March. We all knew the economy had fallen into a recession back in March. If this decision seems late to you, you’ll be shocked to find out that this was the quickest recession call ever.
On average, it takes NBER 11 months to state when recessions and expansions start. Previous quickest call was 5 months in the recession in 1980. Usually, the recession is over or almost over when NBER makes the call. This one is no different as it seems like the recession ended in May.
A recession doesn’t need to last 2 quarters or have negative GDP growth. This quarter will surely have negative GDP growth, but this recession will be very short. On this topic, NBER stated, “The usual definition of a recession involves a decline in economic activity that lasts more than a few months. However, in deciding whether to identify a recession, the committee weighs the depth of the contraction, its duration, and whether economic activity declined broadly across the economy.”
This recession is over because of the jobless claims numbers and the BLS report. Last time the economy was in a recession with a positive jobs month was January 2008. Time before that was March 1980. Considering the fact that the economy is clearly rebounding, it’s only a matter of time that the recession ends. It will either be officially over in May or June. That doesn’t mean the stock market will go higher or that it’s all smooth sailing from here. Recovery could be lumpy.
Risks include, the 2020 election, fiscal policy, and a 2nd wave of COVID-19. The stock market is completely ignoring the possibility of higher corporate taxes, fiscal stimulus being taken away, and COVD-19 coming back. It’s shocking to see how confident investors are that COVID-19 is officially over. It seems like they are just following concurrent data and completely ignoring the future.
Data is shown in the chart above. As you can see, the global Citi surprise index went from -80 to positive 3.2. That’s an amazing turnaround which has occurred because economists became more negative and the data has gotten less bad. That’s the perfect combination to make stocks go higher. However, recognize that this index is highly volatile.
If the recovery stalls out, it will be a major disaster because the unemployment rate is so high. Recovery stalling out this fall would be similar to the last recession being extended. Obviously, everything depends on the speed of the recovery. Stocks are pricing in such a spike in earnings next year that this needs to be the fastest recovery ever for valuations to come close to making sense.
Valuations aren’t cheap even if you assume the best case scenario which is $170 in 2021 S&P 500 EPS. It’s debatable what should be considered the high water mark. Certainly, that’s a good result given the downturn in 2020 EPS. It wouldn’t be surprising to see very strong EPS growth if everything goes smoothly because the economy was shut down for a couple months and this could be the fastest recovery ever.
And very fast recovery lapping the deepest recession since the Great Depression is good for growth. A 19 PE multiple on next year’s best case scenario earnings is very high. I don’t think stocks should be this high. It’s all about momentum. Best case scenario is zero return for the next year to justify that valuation with a few corrections along the way.
As you can see from the chart above, there are a few reasons why EPS might be lower than $170. One of the biggest potential negatives is a tax increase. Higher stocks go, the more political momentum there will be for a tax increase. Visualize a scenario where Biden wins the presidency, the stock market is at a record high, and unemployment is at 8%. It would be a layup to get the corporate tax rate a few points higher.
S&P 500 can fall to 2,550 if the index earns $150 in 2021. That’s based on a fairly generous multiple of 17. That gives the market 21.1% downside from here which is a bear market in itself. It would be interesting to see the market get all the way back to the February peak and then top out.
COVID-19 Isn’t Over
New York City is in phase 1 of its opening. Phase 2 will start in July. While New York is doing great, some areas of the country aren’t. On June 8th, there were 2,279 new cases in California and 1,486 in Texas. Good news is the cases seem to be getting less deadly. There were 373 new deaths on June 7th which was the lowest since March 26th.
Charts below show the latest data in Arizona which has been experiencing a flare up. Hospitalizations are at a record high, but deaths aren’t. That suggests the heat can’t kill off this virus. Bad news is states that are reopening are seeing a spike in cases. Georgia was looked at closely because it was one of the first states to reopen. However, Georgia appears to be an exception.
Personally, I don’t think any of the states will close again if there is a further spike in cases because we have learned a lot more about it in the past few months. The only way we see mass closings is if the virus mutates and becomes worse in the fall. On the other hand, many people won’t want to live their lives normally if they read about an uptick in cases.
Source: First Rebuttal