It certainly looks like volatility is here to stay for a while. Markets hate uncertainty and we have a lot of it at the moment. Stocks fell precipitously on Wednesday, followed by another 1% drop Thursday morning. Fortunately, some great housing numbers and a possible Mnuchin/Pelosi stimulus meeting helped turn things around as the major averages finished the day fractionally higher. More importantly, gains were pretty broad based. Utilities and Consumer Staples led the way, but Cyclical sectors including Basic Materials and Financials, were not far behind. Healthcare was the biggest laggard as a cloudy future for Obamacare creates a muddy earnings picture in future years. All of these gains are getting wiped out, and then some, in pre-market action.
On the housing data front, August’s new home sales jumped +4.8% to a 1 million annual pace, well above estimates. This is nearly 13% higher than long-term demographic demand. It is also the fastest pace since September 2006. The housing sector has benefitted from pent-up demand, low used home inventories, a shift from cities to suburbs, and a massive increase in demand from millennials. The more we work from home, the more demand there will be for larger homes with office space. Low interest rates help affordability as well.
That is only one sector of the market though. Many others are still suffering dramatically from the pandemic and forced closures. We all know restaurants, office buildings and the leisure areas are nowhere near back to normal. What was spent there is now being spent elsewhere. Divergences from sector to sector creates winners and losers in the same economy. This bull/bear debate leaves much to chew on. Let’s start with the negatives and end with a positive note for the weekend.
• Stimulus – Neither political party wants to give the other a “win”, no matter how many unemployed people may need the assistance. What was once a given now seems unlikely until after the votes area tallied up in November (hopefully). Many are back to work, but millions are still scraping by. The rising stock market does not help them. An agreement here would likely add a few percentage points to the averages. The sooner, the better.
• Election uncertainty – Many will glob on to Trump’s vague comments about not leaving the White House if he loses the election. Others will point to voter mail fraud as a real issue. No matter what side of the aisle you reside on, there is some fear in this election cycle from both parties. A delayed conclusion to Bush/Gore resulted in an 8% drop for equities. The market is simply a balance of supply and demand. If a portion of investors want to keep cash under their mattress instead of owning stocks, prices will fall as there are less buyers.
• Covid – case counts are rising, especially in Europe and across college campuses. Some are going back to personal lockdown mode, not leaving their homes until numbers improve. Again, this creates a subset of investors who will wait on investing and conserve cash.
• Valuation – Even with positive revenue momentum coming off the lows, analysts are only expecting ~$145 in earnings next year for the S&P. Today, that puts the market at 22x forward estimates. This is well above the average of 15x. The market is cheap relative to interest rates, but there are not many periods in history that resulted in outsized gains when buying at 20+ PE’s.
• Volatility – the VIX is still elevated, touching 30 yesterday. A stable bull market typically resides in the 12 – 16 zone. Anything above that leads to wild swings. Yesterday alone the Nasdaq opened down 1.1%, bounced 2.2% higher, dropped another 1.3% then moved back to the highs for the day. This is not normal action.
• Economic activity – Warm weather and pent-up demand led to a solid bounce in August relative to the prior months for retail, restaurants and even flying. Those reversed course again in September as TSA checkpoint numbers are now flatlining along with OpenTable reservations. We’re not out of the woods yet.
• Federal Reserve – short-term movements aside, it pays to not fight the Fed over the long haul. Anchoring short rates at 0% is extremely stimulative. Borrowers will create ample demand via low cost funding. A lot of new projects/companies are going to be created and fail, but plenty of billion-dollar ideas are already being started today with cheap funding.
• Vaccines & treatments – Governments around the globe handed out billions of dollars while also reducing the regulatory burden in finding a cure or treatment option for Covid-19. This is critical in timing. Typically, pharma companies are reluctant to spend capital for minimal return. They are also weary of introducing a product that does not undergo extended clinical trials for fear of lawsuits. Take those away and you accelerate the timeline.
• Consumer net worth – rising home prices and a rebounding stock market are helping consumers (who still have a job) feel better about their net worth, which is now at all-time highs. This indicator precedes GDP by about a year. Most consumers are wealthier today than a year ago. That leads to spending.
• Stimulus – Yes, this is under both categories. Even with bickering in DC delaying extra payments, it will eventually happen. The first year after an election cycle typically contains some sort of spending bill to show voters they mean business. More cash in consumer’s pocketbooks until treatment options arrive will help keep demand elevated.
• Long-term interest rates – The effects of lower long-term rates can be seen in autos and homes. Both have sales that skyrocketed back quicker than any other recession we’ve ever seen. The ability to keep monthly loan payments low allows the incremental buyer to close on a purchase.
• Earnings – Several off-calendar companies have already reported quarterly updates this month. The majority (Nike#, FedEx, CarMax, Costco# and KB Homes) smashed analysts’ estimates. This group is on pace to beat their 2019 results already. The bigger the company, the easier it is to take share during a recession. This helps move the stock market.
• Pent-up demand – The big winners this year benefitted from the shutdown. Next year, the losers should be able to get back to growth as we crawl out of our homes. The consumer savings rate is still elevated. That excess cash in checking accounts is fuel for our return to normalcy.
All in all, it looks pretty balanced in the short run. Many of the bear bullet points are near term issues that should be resolved over the coming months. The longer term trends will be back in vogue, led by super easy monetary and fiscal policies. However, the trading range could widen before that occurs. Typically, 200 day moving averages for stocks and indices are good support levels. That’s 8% lower from here on the S&P 500. We are already down 9.5% from the highs. Today’s prices make risk/reward neutral. In times like this, we will continue to rely upon world-class operators with clean balance sheets and product lines that “win” in the new normal.
September 25th is a big one for birthdays. Will Smith is now 52. Star Wars actors Donald Glover and Mark Hamill turn 37 and 69, respectively. Married couple Catherine Zeta Jones and Michael Douglas share the same birthday but 25 years apart at 51 and 76. Barbara Walters hits 91 today.
James Vogt, 610-260-2214