Stocks rallied on Friday on hopes that news of a possible drug therapy for Covid-19 would ease fears and open up the economy quicker. Any steps toward a better treatment should be viewed positively. But any treatment is still months away. Most treatments tested to date are just that, treatments, not cures. They are targeted to help the most critical patients. The one touted on Friday is an injectable only suitable for intensive care hospital settings.
Over the weekend, the news continued to be sobering. Some states are talking about easing some restrictions but, for most major population and economic segments of our economy, lockdown continues to be the position.
Public health officials seem in agreement that for any reopening to be successful, there must be adequate testing available to track and defuse new emerging hot spots in order to control future spread of the disease. Covid-19 isn’t about to disappear in May or June. The goal, rightfully, is to contain future spread to a level that our medical infrastructure can cope with the disease. Without trying to get into the blame game, one clear gap to date has been the inability to track and trace the course of the disease adequately. We are close to having enough testing capability but still lack pieces of the pie that will make tracking and tracing ubiquitous. Notably lacking is lab capacity and the inability to get results from tests quickly. While the White House and states have been pointing fingers back and forth as Americans become increasingly frustrated with home confinement, clearly it is a Federal responsibility to increase the tracking and tracing capabilities. States are better suited to determine how to implement the process, when to reopen, and when, if necessary, future localized quarantines are necessary.
We are starting to see more public protests as Americans get more frustrated with home confinement. Some public officials have gone a bit too far with some confinement restrictions, only adding to the angst. The pressure will force some relenting by those who put public health too far in front. There has to be a balance. We are starting to see the line of bankruptcy filings. Neiman Marcus is ready to file this week. The company was on a path toward bankruptcy before the virus emerged, but clearly the closures have accelerated the process. JC Penney won’t be far behind. The longer the shutdown continues, the larger the number of small businesses that won’t reopen. Every day closed, the economic hole the virus digs gets deeper and deeper. At some point, entrepreneurs simply give up, even if loan money is available. May will be a critical month. I expect literally every state to have a plan in place before the end of May to allow some activities to resume.
Of course, the fact that you and I can now go out to eat doesn’t mean we all will. Evidence overseas suggests that recovery will be a slow, elongated process that will probably continue for a long time, even past the time when vaccines start to arrive. Public health officials warn of a surge again in the fall. That is a prediction born out of caution rather than fact. The virus could well wane a bit in the summer heat allowing for some reprieve, and then it is anyone’s guess. What we do know is that social distancing, washing hands, and other measures limit the damage. They don’t eliminate it. Therefore, unless mass lockdowns resume in the fall, it is safe to assume that some level of disease will be active for some time, and the economic damage will continue. Rebuilding will go on well after a vaccine arrives. It will probably take until 2022 or even 2023 for GDP to recover to 2019 levels.
For equity investors, however, there is a counterbalance, the rush of newly created money to compensate for the loss of business. It would be nice if there were a one-to-one relationship between where the money flows and where the hurt is concentrated. But no one has invented a system that can target needs that accurately. Congressional actions target where money goes specifically. But Federal Reserve liquidity actions don’t. Cruise lines are shut down as Amazon’s orders are bursting at the seams. Supermarket volumes are up 25%+ while other stores are closed. The US government is giving airlines tens of billions of dollars but that will run out by the fall. A lot of the money that is falling from the sky will find its way into the hands of businesses and individuals that desperately need it. But some will also find its way into financial markets, invested until spent. Whenever the Federal Reserve injects liquidity by buying securities in massive amounts, an unintended consequence has been rising asset prices. That means stocks go up and bond yields go down. Obviously, money flows aren’t the only determinant of the prices of financial assets. But when money flows, its impact is outsized.
That is one explanation for why stocks are doing relatively well against an awful economic backdrop. Given what I just said, there are still plenty of non-believers. The level of short sales today in the major ETFs is over 50% higher than a year ago and at near record levels. Clearly, professionals don’t believe this rally is sustainable.
With that said, calls for new lows require that the pain suffered by the market to date gets spread out more. Stocks of airlines, cruise ship operators, oil exploration and service firms, etc. are already down 50% or more. Wholesale bankruptcies could push them lower, should they occur. But the Federal government is trying to keep them alive. But for the market to set new lows, it is going to have to be the winners that cede the most ground. Markets won’t set new lows with Amazon and Netflix trading at record levels. I am not making any predictions beyond the fact that I expect the March 23 lows to hold. My point is simply to say to the most bearish that crying wolf has to be supported by the data.
The fact of the matter is that the virus has caused a great economic upheaval. Take hospitals. Emergency rooms are full, and tremendous resources are used to treat Covid-19 patients. Babies continue to be delivered. But there is no elective surgery. No one is having a colonoscopy today. When the virus disappears, will everything go back to exactly what it was before? Probably not, but we can’t be sure yet of the changes. That same thought can be applied throughout the economy. What we can say, however, is that many trends already in place will be accelerated by what is taking place today. Think about the move away from cash, more online shopping, or food delivery.
We remain in earnings season. That will only add to near term volatility. Over the next two weeks, the world will start to reopen. We will see, market by market, the reaction. How quickly do restaurants fill up again? Will there be baseball season, and will fans be present to see the games in person? We won’t have all the answers over the next 30 days, but we will at least see some plans. No doubt makers of hand sanitizers and thermometers will thrive!
Stocks will react, as noted, to the news and money flows. The money flows will be a tailwind, but the news will be uneven, sometimes hopeful as it was last Friday, and sometimes bad when sour earnings are reported. Today, stocks are probably on the high side of what anyone can call normal after two good weeks. What I do think is happening, however, is that fear has dissipated to the point where most investors want to consider buying the dips as opposed to using rallies to liquidate. That doesn’t mean taking profits here isn’t prudent. There are companies damaged by Covid-19 that may not recover for years, if ever. I would use any rallies in these stocks to lighten. In my mind, the likely long term winners are now a bit expensive. They are the ones you want to buy on dips.
Today, Jessica Lange is 71. Star Trek’s George Takei is 83.
James M. Meyer, CFA 610-260-2220