Monthly Outlook: July 2020
In early June, the NBER declared that the U.S. officially began a recession in February. That’s pretty obvious to anyone paying attention. The virus stopped the world economy in its tracks unlike any war or catastrophe ever has. The initial shock drove the stock market down 33% in March. Then, hope and stimulus helped to fuel a stock market rebound of 35% in April, May, and June. Today, stocks (S&P500) are just 9% lower than the peak in February. It’s hard to rationalize that the world is only 9% worse off today when compared to February, but that’s how stocks are priced.
Let’s consider the facts: Unemployment has spiked to about 13%, a record high since the Great Recession levels of the 1930s. Corporate earnings of the S&P500 have already sagged from $139/share at 2019 year-end to $116/share by March 2020. Professional analysts expect earnings to further sag to $92/share by year-end 2020. That’s a 33% decline, which seems plausible. But investors are looking past this 2020 earnings cliff and expect earnings to somehow rebound to $146/share by year-end 2021. The bet that 2020 will be a short-term blip and the economy will be back to normal in no time is a too-optimistic wager, in my view.
Many stores and businesses are still not completely open and there is no cure or meaningful treatment for coronavirus yet. We’ve weathered the initial shock of the virus in March but have only begun to accept and adjust to the fallout. So why has the stock market rebounded so much? Free money! The Federal Reserve has printed trillions of dollars to buy bonds and other assets and Congress has authorized additional trillions for stimulus programs. That much money can provide a lot of short-term hope and a buying frenzy. But is this level of stimulus sustainable?
Not All Stocks Are Participating
The headlines that stocks plunged 33% and rebounded 35% are factual, but misleading. If we look at components of “the stock market” we can see that many are still below their 200-day moving average trendline. U.S. Value stocks (financials, energy, staples), U.S. Small Co. stocks, European, Asian, and Emerging market stocks are all down-trending. The only components that are up-trending are U.S. Growth stocks (technology, some health care). That’s it. In fact, if you take out just five stocks (Facebook, Apple, Amazon, Microsoft, and Google), the S&P500 would be significantly lower. These five stocks are up about 20%, YTD. On the other hand, the equal-weighted S&P500 is down 11%. Furthermore, these five stocks now comprise 21% of the S&P500, by weight. That’s amazing. Some investors have chased performance by buying these five stocks to dizzying heights in price and valuation. What will they do going forward? If nearly all stock markets are already down-trending and these five stocks are over-done, where does one find growth now? The point here is that stocks are much weaker than the headlines suggest. The S&P500, itself, is teetering on its 200-day moving average trendline. The S&P500 would be back in a bear market if it tipped just 1% to 2% lower. We’ll see.
Remember Why You Invest
With so much market volatility and economic uncertainty, it’s a good time to remember why you invest. Wealth can be used to pay off debt (past consumption) or to save for a goal (future consumption). For many, the goal is to achieve steady growth and, at the same time, avoid the big loss! Stock markets have historically risen about 75% of the time so it’s easy to focus on the growth side of the goal. But down markets occur about 25% of the time and they can be sudden and devastating. Managing for both growth and protection should be every investor’s dual goal, and it’s ours.
Today, July 2020, is a particularly important time to manage risk. Valuations are at peak levels only seen a few times in the past 100 years. The U.S. has entered a sudden and broad recession with a lot of uncertainty about how and when it will recover. “Right now,” is the best time to have a protection strategy in place, before you need it. Our strategy to avoid the big loss is to sell holdings that cross into down-trends. We can’t predict the future, but we can be ready to invest for any situation, and we are.