Stocks continued their recovery on Friday as election uncertainties faded and economic data continued to support the pattern of a recovering economy. Over the last couple of weeks, leadership has rotated back and forth between growth and cyclical stocks. But in the end, almost all moved higher. Energy, the weakest sector all year, was actually the leader on Friday. The spark last week was news from Pfizer that its vaccine was surprisingly effective. News this morning from Moderna seconds that.
While markets are soaring, Covid-19 cases are spiking. Unlike the spring, when the virus’ impact was concentrated in a few major cities, this time it appears to be everywhere. In big cities and small towns. Among the old and the young. And the pace of new cases is accelerating. While we all know, in a world with limited therapeutics, that the best prevention is isolation, few are willing to even consider a return to the quarantined state many of us experienced 8 months ago. Indeed, public health officials agree that while total isolation would certainly slow the spread significantly, it is both economically and socially impractical. Some states imposed few, if any, restrictions last Spring. Most of those aren’t stepping in now either, other than to acknowledge that wearing masks, keeping apart, and washing hands often is good health policy. Others will likely impose renewed restrictions starting this week, which will include short-term school closures, as well as limits for restaurants, gyms, and other places they believe are major sources of viral spread.
Many investors are left scratching their heads. There is little doubt that the current surge, in many ways the largest of this pandemic, will alter behaviors in a manner that will slow down economic activity. We may not have seen the response yet in the data being reported. But I will point you to one fact from the Spring. On March 16, over 1.25 million people passed through TSA airline checkpoints. One week later, the number was down by 75%. It would decline by another two-thirds by early April.
I am not an epidemiologist. But being a stock market analyst requires one to try and guess future economic behavior. If you remember your credit card bills last Spring, they were sharply lower than they were last winter before Covid-19 appeared on our shores. While I am not predicting a return to a full quarantine (Americans simply won’t tolerate it), with the election no longer dominating the front page we are going to be inundated with bad Covid-19 statistics for the next several weeks. For many, particularly those over 40, we won’t need governments to tell us to avoid indoor dining, we will do it ourselves.
But it won’t be as bad as the spring economically. We aren’t going to wipe down Amazon boxes with alcohol. Golf and other outdoor sports will continue. Instead, the focus will be on the real spreader events, notably large gatherings. Thanksgiving and Christmas gatherings will suddenly get a lot smaller.
Even if we don’t head back to the bunkers, there will be some economic impact. At best, growth will slow. I will be surprised if the number of airline flight cancellations doesn’t rise soon. More schools will go virtual and probably for longer than initially planned. When the first 10 minutes of the evening news every night starts with a look at overwhelmed hospitals, future human behavior isn’t hard to predict. Welcome to the next toilet paper shortage.
This brings me back to the initial question. Why are stocks rising as Covid-19 cases spike? For one, the spike is temporary. Today’s vaccine news from Moderna reinforces that. It may last a month or 4 months, but it won’t last forever. Second, a vaccine was a dream in March, it’s a near reality today. That may not help during the current surge, but it does promise relief by mid-2021. Third, investors panicked in the Spring. Those who sold did so at the wrong time. They don’t intend to make the same mistake again. Fourth, interest rates remain extremely low. The 10-year and 30-year Treasury yields have risen a bit lately. But if economic activity is about to slow, those yields could fall back again. Low yields equal high P/Es, an equity investor’s best friend. Fifth, we have learned that in a pandemic, some companies can benefit. Others quickly make changes that produce positive economic results.
But with all that said, we can’t be complacent. Stocks were setting record highs in February 2020 as the virus was first appearing in the U.S. When the impact hit, it did so suddenly. Stocks fell 35% in five weeks before recovering. Now look back to the last quarter of 2017. Stocks were on a tear right up through the end of the year. Investors waited to harvest gains until early 2018. But the rally continued through January. Investors held on not wanting to get off the gravy train too soon. That turned out to be a mistake. In February, stocks fell sharply, losing well over 10% in just six days.
Right now, everyone seems optimistic. Today’s vaccine news reinforces the optimism. Technicians everywhere talk of the S&P 500 going to 3800 by year-end and 4000-4500 shortly thereafter. The idea of a viral surge that slows the economy down doesn’t even register. If it does, it is viewed as a temporary blip.
That may be so. Stocks traditionally rally at year end, particularly in years when the market is up. But there are reasons for some caution. Congress failed to pass another stimulus bill. As a result, some extended benefits from the earlier packages are running out. There are no more PPP loans. The safety nets for many are soon going to sprout holes. Life may return to normal in the second half of 2021 assuming vaccines are readily available by then. But businesses that couldn’t survive won’t come back. During the stock market recovery, we have yet to see a 10% correction. We have learned in recent years that when corrections come, they are swift and sharp. One old saw on Wall Street is that stocks ride an escalator up and an elevator down. In recent years, the declines have been very rapid.
It’s near year end. For some who were overweighted tech stocks, it was a good year, maybe even better than a good year. For value investors it has been a bumpy ride, perhaps one that has seen more losses than gains. At year end, it’s always a good time to reassess. Some of the value names remain bargains. Others are value traps and need to be discarded. For growth investors, valuation always matters. It just isn’t apparent during momentum driven markets. Take some profits.
My chief concern now is that the impact of the current Covid-19 wave will be harsher than most investors believe, not necessarily on the Fortune 500 companies, but on medium and small businesses that won’t survive the current surge.
This isn’t a time to chase. The economy’s course doesn’t resemble a runaway freight train. Even if the current surge subsides soon, the pace of recovery will be slower from here than it has been for the last six months. As the cold weather sets in and outdoor dining fades, more restaurants and small shops will die. I live in the center of Philadelphia. Along the main shopping street, Ann Taylor, Papyrus, Forever 21, Modell’s and Lucky Brands are all gone. Gap is closing. The only new store is Allbirds. Soon many small restaurants will close. Quite a few already have. The worst economic impact of the pandemic may be behind us. But to assume that once the vaccine appears all those empty store fronts will have tenants is beyond optimistic. Ditto all the empty office space. It will take several years to fully recover. We are headed in the right direction. Hopefully, the current surge is simply an economic speed bump. But the market’s euphoria seems to be pricing in a better picture than I paint. Either I am too pessimistic, or markets will have to adjust sooner or later.
Today, Maggie Gyllenhaal is 43. Lisa Bonet is 53.
James M. Meyer, CFA 610-260-2220