Stocks fell sharply on Friday, partly on profit taking and partly related to yet another threat of tariffs against China by President Trump.
The most recent tariff agreement puts some burden on China to accelerate the purchase of American goods, particularly agricultural products. Obviously, the current pandemic throws a monkey wrench on that commitment. Chinese purchases to date certainly don’t live up to its commitment. Mr. Trump also expresses the belief that lack of action early on to contain the spread of Covid-19 is a major factor in the pandemic we now face. Whether China could have contained the virus or not, he has at times threatened to punish China for its lack of action. Certainly additional tariffs would fulfill that threat. With that said, any economic observer would quickly come to the opinion that more tariffs now, against a backdrop of a U.S. economy collapsing at a high double digit rate, would only accelerate the decline. Whether Mr. Trump would actually implement more tariffs now, or simply threaten to do so, is an open question. This is election season and the President is going to play to his base a lot over the next several months.
While Mr. Trump didn’t create the pandemic, critics have criticized his administration’s efforts to contain the spread. I don’t want to get political. What has happened to date is something we as investors have to live with. Rather, we have to factor in expectations of the economic consequences going forward. How bad will the economy be and for how long? When will there be a therapeutic cocktail that dramatically reduces the effect and mortality of the virus? When will there be a vaccine? Will a herd immunity come first?
Right now, the majority of states are making plans to begin opening their economies. So far, most of those plans start with very small initial steps. Even then, we don’t know once stores and restaurants reopen how fast business will rise to the volumes necessary to keep these establishments afloat. We will learn a lot over the next 30-45 days.
As a sidebar, I personally like to play golf. Golf is one of those activities with limited Covid-19 risk. It is outdoors. Most of the time, the players are spaced well over 6 feet apart. There is no need to touch each other. Minor modifications, like one person per golf cart, can reduce the risk further. But government officials want to mettle. I think they feel a need to be actively involved. Instead of understanding that no one who plays golf wants to come down with the virus, and, therefore, will take obvious steps to limit any possible exposure, they add in a bunch of silly rules. Some states have limited groups to twosomes. Others eliminate the ability to warm up at a practice range. No one other than the player can touch a golf bag. The list goes on.
These are the type of dumb rules that will accompany reopening. To be sure, there are basic rules that make sense, mostly involving social distancing and the wearing of masks. But the dumb rules are going to disappear quickly. It is part of the process of life moving in the direction of normal. There are not a zillion Covid-19 microbes that have been sitting on top of a bucket of range balls for six weeks waiting to attack the first golfer that threatens to hit them. The virus spreads by droplets. It won’t infect someone who wears disposable gloves and who puts your bag back into storage when a round is complete.
Even legitimate rules make limited sense if not enforced. One of the prettier places to hang out in Philadelphia on a nice day is Rittenhouse Square. This weekend many did just that, more often than not in small groups spaced much closer than six feet and most not wearing masks. I don’t expect police to roam parks and arrest those violating rules. Rather we all know what we should do. Many follow the guidelines and that will help to limit community spread. But as the world restarts, and it is virtually the whole world, we need to understand that less social distancing will mean more virus spread. Perhaps that can be offset in the coming months with the retardant impact of warmer weather. That’s an unknown. My overall point is that we all need to understand and accept that reopening entails risk. Individually, we will decide how much risk we are willing to take. That, not government rules, is going to determine how fast the economy can recover.
Some parts will recover quicker than others. A popular store like Lululemon will get back toward normal a lot faster than the restaurant next store. Social distancing and sit-down restaurants aren’t compatible. New York City subways are almost empty for obvious reasons related to the virus. Once New Yorkers leave their homes, subways still won’t be crowded.
Perhaps the best place to look for answers is the airlines. In early April, traffic was down to 5% of capacity. Airports were ghost towns. Planes often flew with 10 passengers or less. To their credit, the airlines have stepped up efforts to clean and disinfect planes better. They are requiring masks. They are even handing them out. Some will take your temperature to see whether you are a risk to others. Will people fly again? The answer is clearly yes. The real question is how fast will the flying public return? That remains an unanswered question. But we will learn some of those answers over the next 30-45 days.
Wall Street hates uncertainty. With that said, stocks have been on a tear since the March 23 low. Some stocks had recovered all their losses as of the middle of last week. That is non-sensical. I realize all the Federal Reserve and Treasury steps to increase liquidity also provide fuel for the rally. Low interest rates support even higher P/E ratios. In some cases, the higher P/Es offset the impact of lower earnings. There is something called the equity risk premium. It measures the spread between the expected return on stocks and the return on long-term Treasuries. If Treasury yields fall along with inflation expectations, all things being equal, the risk premium rises. The offset to reduce it back to normal would be higher stock prices. Lower earnings also lower the risk premium. Tariff threats reduce earnings expectations.
Thus, we are wandering in a sea of unknowns. We are always in that ocean. But right now, the seas are unusually choppy. We don’t know how fast the economy will restart. We don’t know how long the impact of the virus will last. We don’t know how many businesses won’t survive the storm. Of those that do, we don’t know whether there will be permanent damage. We can make educated guesses. As the world reopens, we will get better insight as to the rate of progress. Of course, any spike in new Covid-19 cases will have to be factored in.
What I can conclude is that without a huge summer spike forcing further closures, we are probably past the worst. That doesn’t mean the 30+ million people out of work today will all be back on the job soon. It just means the hole that has been dug for us isn’t going to get deeper. Now we have to figure out how to climb out. Therapeutically, we will get some help in the months ahead, but the end is either an effective vaccine or herd immunity. Neither is likely over the next several months. All the government interventions aren’t going to make the world safe. We each will decide how much risk we are willing to take. Governments will prevent extremes in stupidity. There won’t be concerts this summer for instance, nor large political rallies. But the rest is on us. The virus isn’t going away near term, but we won’t have a pandemic for years either. One or two years of weak earnings won’t destroy the value of first class companies. You may not go to Europe this summer, but it is unlikely you have made your last overseas trip. The current correction in the stock market is part of a process. With the worst most likely behind us, investors are going to buy the dips. A good part of recent gains came from short covering and those overly negative on the stock market scrambling to get back in. Momentum chasers. One characteristic of this market is that moves are sharp. Select your buy prices and don’t be afraid to start buying if your targets are met by any further decline. While markets move quickly, you should move slowly. Don’t commit all your reserves at once. Nibble on weakness but keep some funds in reserve should prices go lower.
Today, Rory McIlroy is 31. Sportscaster Erin Andrews is 42.
James M. Meyer, CFA 610-260-2220