Stocks rose about 1% on Friday capping the best week for equities since 1974. The economic news certainly wasn’t the driver. Over the past three weeks over 15 million Americans have filed for unemployment. The unemployment rate for April is likely to exceed 15% and could rise above 20%. Second quarter GDP will almost certainly fall at a greater pace than 20%. What sent stocks higher were three virus related factors. First, the number of new cases has begun to flatten in cities and states that were the first to lock down. This follows similar patterns all over the world. Second, Washington is beginning to discuss when to start reopening the economy. Finally, the Federal Reserve and other central banks around the world have set in place programs to provide funding for businesses that could carry them through a lockdown that might end before the start of June.
But that’s still a big IF. President Trump has said the decision when to reopen the economy will be the most important decision of his life. Clearly, from a public health point of view, keeping everyone in place longer will allow fewer to become exposed. On the other hand, businesses with no revenue will die. Even with Federal help, the longer the economy is locked down, the greater the number of businesses that will never reopen. Many that will reopen cannot survive operating at 50% of capacity or less.
In reality, it isn’t Trump’s call. Obviously, he uses his bully pulpit effectively and carries a lot of weight. But it is up to governors and mayors to set the rules that will allow businesses to reopen. Today, there are still plenty of areas in the U.S. where restaurants are open, and business is within reach of normal.
Looking at the problem logically, Mr. Trump wants to see businesses restart as soon as practical. His first restart moment, Easter Sunday, is now behind us with no changes made. His next deadline is the end of April. He would like to take some baby steps, if not then, soon thereafter. But his public health team will say, in unison, that’s too soon. Nonetheless, the President, and I suspect the investment community, is hopeful that there will be some businesses that can restart in May, a small but important first step forward.
With all that said, many still scratch their collective heads as to why stocks reacted so strongly last week. Let me offer a reason why.
As we all know, stocks reflect the present value of future cash flows. The word future suggests that stocks are forward looking; past cash flows are largely irrelevant. We all know the next 6-12 months will be horrid. However, move the clock ahead 12 months. Close your eyes and imagine that in April 2021, we live in a world where the virus has peaked. Better yet, imagine that by next April there is a vaccine generally available. A year from now that is exactly how investors will be looking ahead. The horror of 2020 will be history. For sure, the remainder of 2021 will reflect an economy recovering from a big storm. There still will be plenty of cleanup left. But we will most likely have a full baseball season next year. Concerts will resume at some point in 2021 if not sooner. After being vaccinated, we won’t fear getting on planes. We might even consider a cruise (OK, that might be a stretch!). My point is the following. Place yourself a year from now. Calculate the present value of future cash flows of your favorite company/stock. With Covid-19 in the rear view mirror, how different will that value be from what it would have been if the coronavirus had never occurred?
That, actually, is an interesting question. For some companies, I believe the differences will be minor. Technology will keep moving to the cloud, AI will be more prevalent, and semiconductor speed will be everything. Disney World will be open and flourishing. Restaurants will be open and full.
But let’s stop there. There will be many businesses that simply won’t be able to bridge the gap between now and then. There will be many restaurants and small businesses that either can’t reopen, or can’t sustain themselves for long even if they reopen. That means a lot of people being laid off today won’t find new jobs very quickly. Industries in the center of the hurricane, including airlines, cruise ships, hotels, and restaurants, may take years to fully recover.
We saw this after 2009. Banks took years to heal. Housing activity remained subdued for almost a decade. The post-2020 world is going to include the haves and have-nots. As investors, it will be easier to bet on those that will flourish than on those that will struggle.
Thus, looking at last week’s rally, there really is a logic. A year from now, the picture will be dramatically better. We can fuss about how bad the next six months will be and I don’t want the trivialize the importance. But once we all feel comfortable resuming normal lives, the economic world, including profits that drive stock market prices, will return to normal.
With that said, the easy part of the recovery in stock prices, about half of the losses to date, is behind us. We still face horrible earnings reports. There are good reasons to expect the economy to reopen at a slower pace than optimists currently hope. The economic data for the next two months at least is going to be horrid. And, of course, we have an election in November to factor into our models. All progress is a function of two steps forward, one step back. As first quarter earnings reports begin this week, more volatility should be expected.
Today, character actor Ron Perlman is 70. Singer Al Green is 74.