Stocks soared about 9% yesterday, the most in one session since 1933. A variety of factors led to the gain. First and foremost, there was favorable news relative to the coronavirus. More on that in a moment. Second, the market had been deeply oversold. Bear markets often have extreme rallies accelerated by short covering. While many hedged investors have been covering their short positions lately (can’t be too greedy on the short side), many others were caught and had to cover quickly. Third, recent Fed actions to boost liquidity worked. The bond and currency markets started to function in close to normal fashion once again. And finally, optimism grew that Congress was close to finalizing a bill that could provide $2 trillion in direct aid and up to an additional $4 billion in loan facilities. Shock and awe worked.
Readers by now know about my two-day rule. Markets must rise convincingly two days in a row to signal real trend reversal. Yesterday was clearly Day One. We will see whether there is follow through today. Whether the all-clear signal is registered or not, so far the real low for many stocks was the close last Monday, the day the Dow Jones Industrials fell by just about 3000 points. President Trump clearly watched the market as his scorecard received a rude awakening that day, after returning from a weekend of golf and a Monday morning fund raiser. Since then he and his administration have been working hard to catch up, and we have been witness to daily press briefings to outline all the steps being taken.
Interestingly, starting this weekend after another down Friday in the market, we started to hear voices saying that all the public health steps in the world won’t yield the best outcomes if lock-in-place went on so long that it threw the country into a depression. That message seemed to sink in quickly. Hence, the very robust Congressional economic aid package, and comments from the President that he hopes to have the economy start to open up around Easter Sunday. That, of course, has set off a bit of a maelstrom between those strictly focused on public health needs and those worried about the future of the American economy and small business. Naturally, in our bifurcated world, those on the more progressive left view this as a heartless scheme perpetuated by large corporations, while some on the extreme right still think this whole thing is a hoax of some kind. But the debate so far has been relatively healthy. Both sides have legitimate points. Furthermore, some geographies like New York City may have to stay quarantined longer, and some businesses like cruise ships may have to be shut in for longer periods. No doubt, reopening the economy will begin in baby steps and will take several months before everyone is comfortable. The elderly, with conditions that increase their vulnerability, will have to wait the longest to be relatively safe.
But yesterday, when we reopen was less relevant to investors than the idea that reopening was in sight. The likelihood that Congress was ready to deliver economic support was another positive. Finally, the Federal Reserve and other central banks have flooded markets with so much liquidity that key markets that threatened to lock up, like the Treasury, repo and commercial paper markets, started to function again. It brings back to mind September-October of 2008. Make no mistake, a few days ago markets were as close to seizing up as we were in 2008.
Thus, we can see the end of the virus’ peak, perhaps sometime around the end of April. We can see funding mechanisms that will help mitigate the damage. The monetary plumbing has been repaired. Corporate America is stepping into a void to produce the needed masks and ventilators. All seems good. At least it did yesterday.
But let us not get ourselves out over our skis too far. If you have ever had a serious illness, you know that recovery isn’t instantaneous. And not everyone recovers fully. As we look to the time where we can begin to emerge from our homes and resume some semblance of normal life, we must recognize that not every shuttered business is going to reopen. All the expanded Federal spending is going to blow out our deficits. Pouring money on an economic problem may stem a crisis, but when does all that money become paper money? If you drop too much money out of the helicopter, that becomes an increased risk. Interest rates are going to stay low indefinitely, certainly as long as the central banks stay in crisis mode and keep adding more money to the economic infrastructure. That’s great for borrowers, but not so good for banks and other lenders. The Fed is going to backstop a lot of small business loans, but the debt burden ultimately becomes an added cost to small business. Layoffs will soar beginning this week. Wait until you see the jump in weekly unemployment claims. Some may be rehired relatively quickly, but not all. If small businesses, such as a neighborhood restaurant, don’t quickly fill up again, not all staff furloughed will be rehired.
Yesterday, we celebrated the sunshine that is starting to appear over the horizon. It felt good. But when the skies clear and we all go outside, we will have chances to survey the damage. It took the stock market six years to recover to 2007 highs. It shouldn’t take that long this time because we are having a relatively short-term health crisis, not an elongated financial crisis. But the idea, offered by some, that markets will be back to record highs by this time next year seems more than a bit optimistic.
Next month, companies will report first-quarter earnings. March clearly was impacted by the virus. But it will be the going forward comments we will be listening to. There are some that will recover very quickly. But they will be few. Remember, this is a worldwide pandemic. So far, only China and South Korea are really reemerging. In both cases, the economy is still running well below normal. Earnings for U.S. companies this year will be devastated. It would be nice to think next year will be back to normal, but that isn’t really likely. Small business owners will need to dig into savings to save their businesses. Those reserves will have to be replenished. The sharp drop in demand has created swollen inventories of many products, especially commodities. It could take years to rebalance.
Finally, if life is going to go back to normal, when will central banks go back to normal? A valid criticism is that it took until December of 2015, over six years after the end of the Great Recession, for the Fed to undertake its first rate increase. Rates are now back to zero.
Putting all this together, a solid rally off recent lows makes a lot of sense. We can see clear skies ahead and markets are forward looking. Yesterday, we celebrated that vision. But as the extent of the damage becomes more apparent, the celebration will end and the sober reality of the need to recalibrate expectations will begin. That will happen between now and the end of earnings season, about a month from now. Some companies that were in distress before the virus, like many department stores, face an even higher hill to climb after. Airlines may be saved by Federal support, but it may take a long time before they flourish again. My guess is that it might take until 2022 before earnings match 2019 levels.
In round numbers, the high for the S&P 500 was just under 3400. The recent low was a smidge under 2200. Today we sit, after yesterday’s big rally, close to 2450, a bit over 10% from the bottom and about 28% below the peak. Certainly, if the virus starts to fade, all the public health steps work, and businesses start to reopen in mid-spring, there is plenty of room for further upside. If I had to pick an upside target, it might be about 2750. Except for the swoon in the fourth quarter of 2018, most trading since early 2018 occurred between 2750 and the recent highs. The move up to that barrier will not hit all that much technical resistance, it would be a retracement of about 50%, and valuations would be in line with both history and alternative returns in other markets. I am not suggesting we get there in a straight line. Bear market lows often get rechallenged. That is quite possible during the coming earnings season when reality replaces hope.
But I do believe the worst is likely over, barring a nasty trading session today. I would like to see volatility drop and signs of trading exhaustion to truly signal an all-clear. But even if markets slide back, with fiscal and monetary support largely in place, and with signs around the world that quarantine-in-place flattens the curve, investors can see beyond the horrible devastation we are all about to witness in the next couple of weeks as the real pain of the pandemic hits us right between the eyes.
One final comment. Stay healthy and as vigilant as you can. This is a nasty virus, a potential killer to the elderly and those with compromised health. When the doors reopen, the threat doesn’t go away. Indeed, as we interact once again, the threat may actually increase. Keep your distances, wash your hands, and pay attention. Your physical health is the most important.
Today, Danika Patrick is 38. Sarah Jessica Parker is 55. Sir Elton John turns 73.
James M. Meyer, CFA 610-260-2220