Stocks rose yet again yesterday, although finishing below their best levels of the day. Once again, the tech sector, led by the FANG stocks plus Microsoft# and Apple#, was the front runner.
Indeed, if you look at almost any stock except those within the high flying tech sector that have been hitting new highs, you will find very few names that are also standing on new high ground. Groups that rebounded sharply when the economy reopened, from banks, to airlines, to oil companies, have backed off from recent highs. Groups that were viewed as defensive protection such as health care, consumer staples and utilities continue to hang in, but haven’t been setting new highs either. If you view our economy as one coming out of recession and entering a new recovery phase, one would think early cycle stocks like homebuilders would lead. They have done well but are off recent highs.
As noted, this is a market that is being propelled forward by six stocks that now account for close to 25% of the value of the S&P 500, plus a handful of others mostly viewed as beneficiaries in a pandemic era, like some of the big box retailers that have stayed open throughout the recent period of quarantine.
Bluntly put, this isn’t the sign of a healthy vibrant market. Adding to my fears that some sort of correction is forthcoming, is the fact that most of the new money coming into our stock market today is coming from foreign and retail investors, two groups that normally chase a rally rather than help establish it.
About 10 days ago, the leading averages fell close to 7% in just one session. With hindsight, that 7% drop was the entire correction at that time. If you remember my two-day rule, the one-day drop didn’t even trigger a need to retreat. Since then, markets have basically regained most of what they lost, although what has actually happened is that the aforementioned tech leadership names have marched to new highs while the rest of the market has struggled to get back close to prior high levels.
This market bifurcation is nothing new. The tech superstars have been the market’s leaders for years. All six now sell for over 20x 2022 estimated earnings. Amazon is closer to 50 times. Can they go even higher? Of course they can. If trends accelerated by the pandemic make earnings for these names accelerate, they are worth more than their stock prices of just a few months ago. Perhaps that is the best explanation for what has been happening. Business shifting more online can only be good for the likes of Amazon, Netflix, Facebook#, Alphabet#, and Microsoft.
But valuation matters. We all know Zoom video. We are all using it. We probably will still use it when we go back to work as the nation reopens. Soon, we will discover new ways to use Zoom. But is this a company worth over 30 times revenues that still doesn’t make a dime? Can’t the Big 6 incorporate video get-togethers into their own software? Won’t we be able soon to have instantaneous video gatherings on our phone using Apple software? Facebook is already there. In short, valuation matters. Zoom reminds me of Yahoo and AOL 20 years ago. It could become the next Amazon instead and fool me. But I like my odds to say I don’t think so. Rather Zoom is a symbol of the speculative fever in the market today. The correction two weeks ago was a warning now disregarded because it happened in just one session.
OK, I made my point. This market is frothy. But generally, a nice stiff but short correction can correct that pretty quickly. I’m not talking about a bear market like we saw in March. I’m just warning of a correction that, frankly, can happen at any time for any reason, one that shakes weaker hands to run for cover. It could be another 5-10% one-day affair. Or it could be something a little more severe, perhaps 10-20%. For it to be more, there will have to be a fundamental cause.
That, naturally, leads me to the coronavirus. We see every day now reports of new spreads, and rising hospitalization rates. While Dr. Anthony Fauci warns us to be more vigilant than we are, there is a President Trump who views Covid-19 as nothing more than a bad flu season. I won’t enter the political or public health battle, leaving that to others. But what bears watching economically are a few factors.
1. Is the accelerating spread in states like Arizona, Texas and Florida going to reach a level that requires government intervention that could slow the pace of recovery?
2. Even without government intervention, will Americans, particularly those living in the most affected areas, shy away from restaurants, planes, and large venues?
3. Can sports leagues reopen? NASCAR and golf are already there without fans in attendance. But can contact sports like basketball, hockey, and even football be able to cross that threshold?
4. Can schools reopen with in-person attendance?
With rising infection rates, some are warning that this is the start of the feared second wave. It isn’t. We are still in the first wave. The virus hasn’t changed much, but our behavior has. In the first phase, we didn’t know the virus was there. Many got infected because they weren’t aware of its existence. They took no precautions and got sick. It was in nursing homes well before nursing homes could react. The second phase included the lockdown period. We took maximum care, found our masks and kept apart from each other. The spread slowed but the economy withered. Now we are about 6-7 weeks into the third phase. The world is reopening. Those who fear the disease or who need to be vigilant may be a bit less careful, but they have generally stayed clear of additional infections. But those who don’t fear the virus are out and about. They are also the ones now getting infected. Many have noted that the average age of Covid-19 hospital admissions has dropped sharply. What we don’t know is whether the millennials who are now getting sick will infect their parents, or their cohorts at work. It will take another several weeks to find out.
For there to be a second wave, almost by definition the first wave has to end. There are signs that is happening in several countries around the world from China and South Korea to Italy, Germany, and Switzerland. For those countries, especially those with adequate contact tracing in place, flareups hopefully can be isolated, and the feared second wave can be muted. Hopefully.
But if the first wave never ends, how will we deal with a resurgence should it occur? I am going to stop here because (a) I don’t want to extend a what-if discussion, and (b) I am not the one to offer a public health solution. But if there is either a second wave this fall or a blossoming of a first wave, the economic impact will be measurable, even if governments don’t opt to shut the economy again.
Plane travel statistics show that over 600,000 Americans flew on Monday for the first time since the pandemic began. That is double from a month ago, and more than six times April lows. International travel is slowly restarting. But 600,000 is still less than 30% of what it was pre-Covid. No government entity is restricting airline travel in the U.S. Airline travel is strictly a factor of the state of the economy and our collective emotional willingness to fly. I would expect those numbers to continue to rise during the summer vacation season. But they could be tempered by reports of surges in infection in certain areas.
None of this should be lost on any of us. We all see the same news every day. This is all discounted in the market, or at least it should be. What we may be missing is that reopening is easy. You unlock the door and turn on the lights. But staying open means business generates enough cash to justify continuing. How long can a restaurant hang in without half of its customers? How long can a strip mall survive without key tenants? Do cruise ships and airlines have access to the cash necessary to get over the pandemic hump? What about gyms, and nail salons? Will spinning classes only be virtual on my Peloton? When allowed over coming weeks, most of these small businesses will start to reopen. Time will tell how many last.
We have seen a surge in employment that accompanies the reopening process. The government’s PPP program gives some cushion to those trying to stay alive. Enhanced unemployment benefits keep the money flowing even while 20 million Americans are out of work. But these programs all have end dates. Granted, in an election year, the benefits will keep flowing in some degree to at least late fall. But what we really need to ensure recovery are better therapies and a vaccine. Both might appear by fall, but neither will be widely available until next year.
Stocks today sell for 16-18 times 2022 estimated earnings. That reflects both very low interest rates and optimism that by 2022 our economy can achieve record earnings once the coronavirus threat has passed. That is quite possible, but far from a certainty. I doubt all the empty storefronts will be filled that quickly. Offices will remain vacant. Shopping mall traffic may take many years to recover to 2019 levels. Urban centers will have to recreate themselves. Many will still feel uncomfortable about flying or taking a cruise. As I often note, valuation matters. I think the reopening celebration came to an end on that Thursday a couple of weeks ago when the stock market fell 7%. The next chapter is a backing and filling process, mixing hope with reality. I can’t tell you how the economic impact of the virus will play out this fall because I am not an epidemiologist. I am not sure I could if I were. That is why my crystal ball is so fuzzy. But I don’t buy the line yet that this was all a bad dream and life can only get better from here. I think there is at least one more battle to wage when the virus starts to press the ability of our nation’s health care system to handle it. How that battle ends will determine the course of the stock market over the next six months. If it ends well without a major resurgence, the beneficiaries are not going to be the stocks that have led the market recently, but those cyclically impacted by Covid-19. The winners will be the ones celebrating survival. If, however, the virus impact is worse than expected, many of those same potential winners will be fighting to survive.
Finally, a quick word on the Presidential election. I don’t think I am telling you anything novel to say that there has been a stark difference to date between the Trump and Obama presidencies. But economically, there has been virtually no difference. Excluding the last few months of pandemic, both eras showed 2% growth with inflation below the 2% target. I don’t want to go any further this morning other than to note that economically, who is President ends up having remarkably little to do with how the stock market ultimately performs.
Today, soccer star Lionel Messi is 33. Former Sixer JJ Reddick turns 36.
James M. Meyer, CFA 610-260-2220