It's very dangerous to be a bear here
There’s a $4.7 trillion and growing pile of cash on the sidelines, almost unprecedented when there’s a rally. There’s another $1 trillion or so yet to be spent from the last stimulus, a new round of stimulus likely by August, with an opening bid of $1 trillion, and a Fed that keeps pouring it on. Just this week, Chair Powell said the emergency facility buying corporate debt will be expanded to include direct bond purchases, not just exchange-traded funds. Does valuation matter when all this money is floating around and central banks are active players in risk assets? Strategas Research says the answer, for the time being, appears to be a resounding “no.” Liquidity, sentiment and earnings are the basic building blocks of market health, and as it stands now, liquidity is an unalloyed positive with M2 growth up 23% year-over-year and 85% on a 3-month basis. Sentiment is largely supportive—the percentage of bears rose in the latest AAII survey—and individual investors still have more of a predilection for bonds than stocks, a persistent condition since 2009. Indeed, Fundstrat says 30% of baby boomers went to 100% cash during the sell-off. They control 76% of $100T of U.S. household net worth, or $76T. (That’s trillion, with a T!) What remains a great unknown, of course, is earnings. Even in the best of times, estimating earnings is a combination of art and science. With so many companies suspending guidance, Strategas says forecasting earnings has taken on a character of abstract art.
Despite the earnings vacuum, risk appetite is picking up, with investors exhibiting a preference for small companies over large ones and high-beta stocks over low-beta stocks. This is typical whenever an economy starts to pull out of a recession (more below), with cyclical/Value stocks usually outperforming in early stages of recovery as orders pour in and activity perks up. Based on shifts in sector leadership, Ned Davis Research’s proprietary sector bottom-spotter indicator was triggered on May 26. Historically, the S&P 500 has risen a median 21.5% in the 12 months following this signal, with positive returns in 18 of the last 21 cases. Looking at only recessionary signals, the S&P has been up a median of 30% in the following year, with positive returns in five of the last six cases. A key number to watch on any pullback is support around 2,950 on the S&P—if it holds, it would serve to confirm recent breadth and momentum. It could face a big test today as some $2T—that’s trillion, with a T!—of S&P options are set to expire. If we look at the three worst GDP contractions since 1900, the average equity rally is 331%. That math would put the S&P at 9,500 by the end of this run. More abstract art?!
There are legitimate reasons for concerns about a second wave. But renewed worries likely would trigger yet more stimulus in response to any stock market weakness. Powell has said the Fed will keep its “foot on the gas” until we’re through this. So in this sense, bad news could again prove to be good for equities. After the global financial crisis, the Fed worked to reflate asset markets first, creating a wealth effect that increased consumer/business confidence and in the end healed the economy. It took 10 years, but it worked. TIS Group believes some of the same thinking is present now, i.e., it may take 10 years to heal the damage caused by the greatest and hopefully shortest depression in American history. Powell has been asking for more help on the fiscal side and is about to get it. President Trump has proposed a $1T infrastructure bill targeting improvement in roads, bridges, broadband access and 5G upgrades. It is unclear if this bill would be included in potential Phase 4 discussions, or is a separate bill. If included, it seems more likely to pass given bipartisan support for more stimulus. Another $1T to $3T of additional stimulus in this election year. It is very dangerous to be a bear here. I mean, we’re talking trillions, with a T!
- Can the recession be over already? May retail sales soared, with core sales (ex-autos and gas) matching February levels as last month’s gains nearly reversed April's losses. Total retail sales are now 10% below their January peak.
- Can the recession be over already? Philly and New York Fed surveys showed strong improvements in June manufacturing activity, with the 6-month Philly forecast reaching its highest level since 1991. Conference Board leading indicators also jumped in May, partly reversing March and April declines.
- Can the recession be over already? Weekly mortgage purchase applications jumped again, June builder sentiment nearly tripled forecasts and May housing permits soared, the bulk in single-family homes. Its sensitivity to interest rates and the employment outlook make housing an early-cycle indicator.
- Jobs are mired in recession While initial claims continue to trend down, continuing jobless claims—a timely indicator of labor market health—have remained at roughly 21 million for four weeks. Though it expects average monthly job gains of 2+ million over summer, Goldman Sachs estimates there’ve been 25 million net job losses related to the Covid crisis, versus 9 million at the trough of the Great Recession.
- The people losing them can least afford it Half of U.S. households are experiencing a loss of employment income because of the pandemic, with the income losses most pronounced among low-income groups and younger people, Deutsche Bank says.
- Valuations are one more abstract art The forward earnings P/E multiple on the S&P reached a nadir of 10.8x in March 2009; it rests at 22.1x today.
Enthusiasm—Trump’s trump card A CNN poll found among those favoring Biden, 60% said they were voting against Trump, compared to only 37% who said they were voting for Biden. Among those who said they’re supporting Trump, 70% said they were voting for the president, while only 27% said they were voting against Biden. According to The Hill, the candidate who has led on enthusiasm has won every presidential election since 1988, including in 2016.
A stealth bull can be very profitable, too With Growth’s disproportional weight and lofty P/E multiple characterizing S&P performance, the current market looks a lot like it did in 2002. Back then, even as cyclicals/Value stocks rose as the economy and earnings prospects began to recover, Growth's P/E compressed, causing the S&P to decline. This suggests the potential for muted performance going forward, UBS says, or even a steep downdraft in line with the 2002 “Stealth Bull Market.”
A tortured argument for an inflation problem, IMO If Farr’s Law works and the virus burns itself out sooner rather than later, V-shaped recovery expectations should come on with a vengeance, causing a steepening yield curve and market concerns about the withdrawal of stimulus, Jefferies Group says. This is when Powell likely will step in with “yield curve control,” marking the formal introduction of financial suppression and, with it, the likely ending of the deflationary era and the beginning of a new inflationary one.