by Bryan Perry
May 12, 2020
It’s almost impossible for a day to go by without hearing how wonderful the “V-shaped” market rally is reflating portfolio valuations. This is true if one is long the large cap tech leaders or the several not-so-mega cap stocks in the cloud, biotech, and healthcare sectors, plus a handful of big-box retailers.
Those who own stocks in transportation, industrial, financial, real estate, energy, specialty retail, travel, hospitality, entertainment, consumer services, and even utilities are wondering when they will see some genuine recovery. With the majority of states now pushing for phased-in re-openings of businesses, public parks, and facilities, there is great hope that the V-shaped market rally will translate into a V-shaped economic recovery, but it is important to note that the stock market can experience a V-shaped recovery while the economy experiences a U-shaped rebound. The markets are still well below their peaks. From their late February highs to Friday’s close, here’s a snapshot of where the indexes stand from their peak:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Going back three years to May 2017, the differences are starker: NASDAQ is up 66.7%, the S&P is ahead by 21.7%, the Dow is up by 15.7%, and the Russell 2000 is down -5.0%. On a trailing three-year basis, NASDAQ investors have done well, but investors in the other three indexes have not done so well.
Stocks generally bottom before the economic fundamentals, and the faster markets fall the faster markets tend to rebound. If we look at prior market bottoms, stocks bottom before jobless claims peak. In 2002, the lag was about six weeks. In 2009, it was roughly three weeks. And GDP typically takes a full year to recover to its previous level. The current market seems to be sensing a pretty vigorous earnings recovery.
In a May 7 interview with CNBC, Fundstrat’s Tom Lee stated that the market is buying into the notion that companies are pretty good at adjusting quickly to adverse conditions. Studies show that over half the companies in the S&P 500 managed to get back to peak earnings despite harvesting lower revenue.
For instance, the financial sector got to peak earnings with 27% less revenue. In consumer discretionary, over half of all companies were able to get back to peak earnings with less revenue. Homebuilders recovered to peak earnings on 70% less revenues!
Operating leverage is the key story behind that anomaly. In many industries, people working out of their homes give companies an opportunity to control costs. Technology is a key component to this workplace paradigm shift. Mr. Lee says it is very possible that the current 26.7% tech weighting in the S&P could rise to 50% over the course of a few years due to the role of technology in this “paradigm shift.”
For the most part, the jobs being lost are low-wage jobs, with those workers being temporarily supported by a generous payroll protection plan passed by Congress. That means the median income of the jobs lost so far is only about half of the national average for median income. So, unlike the great financial crisis of 2008, where 10% unemployment reflected a 16% hit to income, this time we could suffer a record 26% jobless rate but that would represent less than a 10% income hit for stimulus policies to offset.
While the Fed’s quantitative easing program has been buying $625 billion of Treasuries in the last few weeks – an amount that exceeds what the Fed would buy over the course of eight months in prior bouts of QE – the Fed has all but eliminated the credit crisis in investment grade and high-yield bonds.
Fed Chair Jerome Powell said the Fed is preparing to act on its plan to buy corporate bonds via The Secondary Market Corporate Credit Facility, and buying corporate bond ETFs in the open market, including junk bonds. Buying corporate bond ETFs is tantamount to buying every bond the ETF holds, which both provides liquidity and artificially inflates prices.
We’ve Just Seen the Largest, Fastest Market Crash (and Recovery) in History
According to data just put out by Ned Davis Research, the recent waterfall decline was the largest in history. What’s more, the 33.7% surge from the low on March 23 to the close on May 8 is also the biggest surge on record. (A “waterfall” is a double-digit decline in 70 days or less, but there is no strict numerical definition. It involves consistency: According to Ned Davis analysts, “Most include weeks of persistent selling, no more than two up days in a row, a surge in volume, and a collapse in sentiment.”)
Looking forward, past waterfalls show that “the bigger the retracement, the less severe the retest,” according to Ned Davis analysts. “Five of the six most severe retests happened after below-average retracement rallies. Three of the four mildest retests occurred when the retracement was above average.
The biggest question facing investors this week and further out is: Has the market come up too far, too fast? With the heart of earnings season behind us, with the FOMC meeting behind us, with PPP checks in the mail and states reopening for business, it is only logical to ask what the next catalyst or catalysts to drive stocks to higher levels might be – but tell me something the market does not already know!
To retest or not to retest — that is the question. History has taught us that market bottoming is a multi-phase process. In phase #1, the declines are sharp and fast and typically conclude amid extreme volatility, persistent selling, and a collapse in sentiment. Sound familiar? Phase #2 is a retracement rally, such as the one the markets are currently experiencing. Phase #3 is often a retest of the earlier low.
Regardless of the concerns investors often register about whether markets will retest lows, history suggests whether that happened or not had little impact on returns over subsequent years. The average three-year market return from the initial low in the instances when that low held (1962, 1970, 1974, and 1990) was 56.5%. Surprisingly, when that initial low did not hold (1982, 1987, 2002, and 2009), the average three-year market return after the initial low was even better: 57.8% (source: Invesco).
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
What the market does not know is if the U.S. is safely on the other side of COVID-19 risk. I would say that any resurgence of cases in COVID-19 from the Grand Reopening of America will quickly weigh on market sentiment, leading to some measure of retracement of recent gains. The 3-year chart above suggests that 2,660 is good support for the S&P, or about 9.2% lower than last Friday’s close of 2,930.
If we get that correction (aka, buying opportunity), great, bring it on. Most investors are sitting on some dry powder, which they’d like to deploy at lower levels. If not, then the Fear of Missing Out (FOMO) will start to take over with the S&P slicing up and through technical resistance at 3,000 like a hot knife through butter. Either way, history is on the side of the bulls.
Also In This Issue
A Look Ahead by Louis Navellier
How Fast Will These “Record Low” Statistics Return to Normal?
Income Mail by Bryan Perry
Today’s “Tale of the Tape” is a Technology Workplace Paradigm Shift
Growth Mail by Gary Alexander
Cash is King, but This King is Scared
Global Mail by Ivan Martchev
This is a Different Type of “V” Shaped Stock Market Recovery
Sector Spotlight by Jason Bodner
When Does an “Overbought” Market Become a “Sell” Signal
View Full Archive
Read Past Issues Here
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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