April 15. It takes a pandemic to defer taxes for 90 days!
Yesterday, stocks rallied once again as many puzzled why stocks are rising while Covid-19 cases set new records. But the notion that states are starting to coordinate plans to reopen economies seems to be enough to attract new money.
It isn’t just the hope (and that is what it is for now) that our economies are about to enter restart mode. When volatility spikes, as it did in early March, the way to moderate risk for active traders was to raise cash. As volatility falls, risk can be added back. For equity investors, that means putting cash back into the stock market, pushing prices higher.
The market’s behavior seems perverse. Yes, the number of new Covid-19 cases appears to be plateauing. But the number of deaths daily is still frightening. The number may be about to fall, but not at a rapid rate. Logical thinking says simply opening the floodgates invites another surge in new infections. That may or may not happen, but government officials are not going to suddenly allow a return to the old normal anytime soon. Any way one models Q2 or Q3, the near term outlook is grim.
Clearly, our economic world has been bifurcated by Covid-19. We still owe rent or mortgage payments. We still have to pay for insurance. We aren’t eating less, although where and how we eat has changed. Even with an unemployment rate that could explode to over 20%, most of us are still working. Simply said, part of our economy is functioning fairly close to normal and will recover quickly when the virus threat ends. But other parts are really suffering. For many, livelihoods are now almost non-existent. The future is problematic. Whole industries, in fact, are problematic. We don’t know how many restaurants won’t reopen, or when cruise ships will sail again.
Every recession instigates change. The companies in the center of the hurricane take an extended period to recover, if they can recover at all. So many promising Internet ideas died post the 2000 bear market. Banks imploded in 2008. So did the housing market. This time around, the big hit was taken by leisure and hospitality companies. We have no idea yet, despite all the Federal support, what parts of these sectors will survive, or how others may be altered.
Weak economies always benefit the strong. They absorb the customers left over by those left behind. Recessions also accelerate trends already in place. We are buying even more online. We are streaming more while movie theatres are vacant. Demand for cloud services is escalating. We are learning to use IT to collaborate. Storing data and programs on inhouse servers has been exposed for obvious inherent weakness as everyone vacates offices.
While all this is happening, interest rates have fallen. Finding high quality debt paying more than 1% takes effort. The 10-year Treasury yield is now about 0.75%, having fallen briefly below 0.50% last month. For stocks, the effect is a rising price/earnings ratio. Six months ago, a 2.5% dividend yield was an attractive alternative. Today, almost any stable dividend looks exciting.
When rates fall, not only do P/Es rise but the spread between low and high P/Es widens. Simple math. The dividend contribution to total return becomes less and price appreciation (and therefore growth) matters more. We have seen this in spades over the last several sessions. The haves, names like Amazon and Netflix, have been setting all-time highs while companies that are in the eye of the Covid-19 hurricane, including the banks, energy and leisure companies, remain 50% or more below 52-week highs. The weaker names, should they survive, could provide outsized long term returns over time. But until survival is assured, they will remain under pressure. Some won’t survive. Many Internet companies of the 1990s never recovered. Many actually failed. Banks have struggled to get back to pre-2008 levels after the Great Recession. Cruise ship and airline stocks may rally from current levels, but getting back to 2019 highs may take years.
On the other hand, trends already in place are accelerating. More shopping online. More streaming of movies. More medical testing. Greater use of cloud computing. 5G. The bifurcation in the stock market is obvious. It isn’t going to stop tomorrow. Overall, it is hard to describe the market today as cheap. Stocks today sell at over 20x times 2021 estimated earnings. But the winners can still move higher and those left behind will still struggle. The winners aren’t all in technology. Great companies gain the most share in tough times, whether the market be cars or toilet paper. In easier times, everyone has access to capital. In tough times, great management and access to capital count more. Don’t be trapped in bottom fishing the losers. For every time you nab a bottom fish, you will lose one that fails to succeed. Right now, the best idea is to buy great companies still available at a discount to where they were just a few months ago. The names are obvious. Don’t be afraid to nibble on any weakness.
Today, Seth Rogen is 38. Emma Thompson turns 61.
James M. Meyer, CFA 610-260-2220