The bull roars back
Well, just like that, the fastest 35% decline in the market since 1933 was then matched by the fastest 25% gain in market history. Every reaction has an equal and opposite reaction. An unprecedented global crisis creates an unprecedented global market meltdown. The unprecedented meltdown leads to unprecedented global central bank and fiscal stimulus. The unprecedented stimulus leads to an unprecedented rally as investors perceive a light at the end of this tunnel. Or to summarize a key lesson in Investments 101: Don’t Fight the Fed (much less every central bank in the world at the same time).
So where are we now?
At Federated Hermes, our advice from the last several weeks remains the same: for the brave, average in. For the savvy (or perhaps the overconfident), go ahead and try to trade this thing. For the rest of us humans, hold your positions. They should be worth a lot more in two years, despite the choppy retest that’s going to come at some point. To quote from last week, “We are in a short-term bear market within a secular bull. The lows are in. The bull has the virus, but will survive without that dreaded trip to the intensive care ward. Just be patient.”
‘The Second Derivative’
Over the weekend, my wife read me another worrisome headline out of the New York Times: “Death count rising in New York!” “Steve, are you sure this ‘Bull Market Call’ of yours is right?” My response, “Sweetheart, let me assure you. Every smart person on Wall Street expected that headline. The news I’m reading, the news they’re reading, is the rate of change in infection rates, and even in death rates. And that news looks pretty good this weekend. The market is going to roar on Monday.”
To get technical, the change in the slope of trend line is called “the second derivative.” Over the years, as investors tried to outsmart each other, they increasingly focused on the rate of change of a trend, be it earnings growth, or sales growth, or money supply growth or lately, the number of times in a text search of a 10K that the word “positive” is used. Because before a trend definitively breaks lower, it has to first stop moving as fast in the current direction. And yes, professional investors are even applying this technique to things they otherwise know nothing about, like epidemiology, like the rate of change in coronavirus growth. That’s why, even when things look to a normal person that they are getting worse, forward-looking investors see that the rate of change is slowing, that things are getting less worse. And when stocks are priced for things getting more worse, less worse is a massive improvement. Almost bigger than things actually getting better.
This week, several key elements of the “Corona Crisis,” as I call it, got less worse. All of them have been key elements of the “crisis framework” we launched several weeks ago.
The virus itself: Infections and deaths getting less worse
The numbers themselves, as I alluded to above, largely got less worse this week. Infection and death rates in virus-infested Italy: Down. Infection and death rates in similarly infested Spain: Down. Ditto NYC. Ditto Seattle.
Infection pickup in other parts of U.S., while still accelerating, seems to be “underperforming” dire estimates. Some examples: the Institute of Health Metrics and Evaluation (IHME) at the University of Washington is now projecting 60,000 total U.S. deaths vs. over 90,000 a week ago. Outside of New York/New Jersey, the IHME says the curve is flattening in Louisiana, Colorado, Delaware, Idaho, Kansas, Mississippi, Missouri, Montana, North Dakota, Ohio, Oregon, Vermont, Washington and D.C.
Health-care response: Treatment advances beginning to show (very early) promise
Again, while no-clear cut solution is at hand, a mosaic of solutions is beginning to come to life for investors. Hydroxychloroquine treatment seems to be helping clinically in early stages, even though many doubters persist for sure and “scientists” can’t prove it yet. Ditto for Gilead’s Remdesivir, which seems to be working well to keep critical patients out of the ICU. Although still months away from formal approval, the pharma company that makes the drug seems confident enough, and is getting enough demand from doctors prescribing it on a trial basis, to be ramping up production. Importantly, it seems to be getting a wink from the normally slow-moving FDA for doing so “on a trial basis.” The latter seems to be hopping around quicker these days, maybe courtesy of its new boss, the completely unique Donald Trump. (This would mark the largest ever “Trial Basis” release of a pharma drug.) Various forms of an antibody test to check quickly who’s been exposed and who hasn’t are being tried, and full deployment seems to be weeks, not months, away. Several new vaccine efforts have been introduced into the testing pipeline. Altogether, not a solution yet, but the second derivative of the battle to reduce the novel coronavirus to at least the category of “dangerous but not a death sentence” seems to have turned. This, too, is helping investors begin to see the re-opening of the post-virus economy as a viable prospect.
Policy response: Accelerating
Another second derivative change, the rate of policy response, is also continuing to improve. Hard to match the last week of March’s massive shift in Fed policy, followed quickly by the congressional approval of Treasury’s “stimulus plan,” which really is a giant bridge loan to the entire economy to take it through this dark virus valley. But even on this front, more good news continues to flow in. Central banks around the world are following the Fed. The Europeans are following our lead on fiscal stimulus, even normally frugal Germany, as they debate a $543 billion joint emergency relief package. Over the past eight months, 285 stimulus measures have been announced, the most ever by a wide margin, and more are coming. Japan is preparing for almost $1 trillion and Trump and Congress are concurring on another $1 trillion. Including these two, there has been almost $10 trillion in fiscal stimulus unveiled around the world.
And this doesn’t include today’s big add, the Fed’s announcement that its asset-buying program will include debt of previously investment-grade companies that are being downgraded due to virus-crisis, shutdown-induced cash flow issues, along with municipal bonds under pressure due to virus-associated state budget problems. This was a very big deal within the markets. The bears have been pointing to these coming credit downgrades in the corporate bond markets as a major Achilles’ heel, bringing far more large companies with huge debt programs out of the very liquid and deep investment-grade universe into the small and narrow high-yield universe. The latter market’s total capitalization is only about 10% of the capitalization of the investment-grade world. Ditto for munis. So if not fixed, which the bears presumed would be the case, the bond yields of many otherwise healthy corporate and municipal borrowers would soar, sparking further retrenchment and prolonging the present short recession into something much worse.
As usual, the other player in the chess game, the Fed, is not a dope. It saw the same obvious weak point in the chain. And it responded. This not only solves this problem, but now plants the seeds of doubt even in the always confident bears’ heads: “What if the Fed spots the same weakness next time that I think I’m the only one spotting? Should I really keep betting on this? I just got my eyeballs ripped out of my skull again by these guys! This is unprecedented, maybe illegal! But can I sue the Fed so that I can get the outcome I crave: economic meltdown? For that matter, can I even find a judge these days in Washington? What’s that, ‘the Supreme Court has gone home?’ Oh boy…. Cover! Cover! Cover!”
Economic response: Lagging indicators getting worse, but not the second derivative
The economic response, to be fair, is still getting worse. Today’s claims report, a good indicator, jumped another 6+ million jobs, though importantly, the rate of change was roughly flat vs. the previous week. But let’s face it, 6 million is a big number.
We and the market expect more bad news in the weeks ahead. Housing numbers, auto numbers, air travel numbers, tourism numbers, retail numbers, trade numbers, you name it, will all be alarmingly terrible. Street economists are outpacing themselves to revise down Q2 GDP, with some very well respected ones seeing it sink a full 25%! Frankly, it might be hard for the market to advance much higher as this, and the uncertain earnings guidance that will be starting next week, rolls in.
On the other hand, it might also be hard for the market to plummet on this coming bad news. After all, everyone now expects the worst, so that pesky second derivative could be key. For instance, if the collective guidance we get is, “Uncertainty ahead. But we’ve battened down the hatches and can get through a hard stop like this until at least the end of June. And we’ve got the following plan in place for the restart.” Well, that might be positive by being less negative, less worse, than investors expect. And what if the economic drags that everyone has factored into their -25% Q2 forecast are offset a little by the positive impact of the massive $2 trillion sudden-cash infusion throughout the economy by the government (approximately 30% of the quarter’s normal GDP). For the math-challenged, +30% + -25% = +5%. Every reaction has an equal and opposite reaction.
Stock market technicals: Improving
I’m no technical analyst, but I do find—especially in times of uncertainty—that while history never really repeats, and while every environment is different, every crisis is new, the human psychological response, our wiring, is more constant. Good technical analysts are effectively picking this up in their studies of market technical patterns.
This week, some of the best, most objective analysts we work with on Wall Street started feeling better, not worse, as the bull roared higher, busting through from the downside key long-term support levels that it had sliced through in a flash in late March. “Unprecedented recovery speed.” Again, every reaction has an equal and opposite reaction.
Here are some quotes from Evercore ISI’s Rich Ross, one of the best technical analysts on Wall Street in my view:
- “Markets have made a classic multi-year bottom with a classic retest. This is stuff you only see in the textbooks, it’s so rare. This is classic."
- “Growth stocks (tech and health care) never rolled over or broke their long-term uptrends; they’ll lag now while the cyclical tape bounces hard, but importantly they bought us time. They will resume leadership eventually.”
- “Every cyclical chart looks the same: banks, financials, the Loonie, Retail. Commercial REITS, Builders, Industrials, Even Energy. They’ve all made classic bottoms.”
- “Emerging markets confirm the call: What led us in is leading us out.”
- “If this were a longer-term bear, the ‘bounce’ should have failed at the old uptrend line, 2,650. It busted through it quickly.”
- “This is a classic tweezer bottom, the kind in textbooks that you never see. It’s a once a lifetime opportunity.”
- “Europe and Canada have made classic multiyear bottoms.”
- “For now, the trend is very constructive. Looking for 2,900 to 3000. “
And then the killer punch to the bears’ solar plexus: “People waiting for the retest probably missed it.”
Chris Verrone, Strategas Research’s technical analyst and another very objective player whom I deeply respect, makes virtually all the same points about this rally. Hmmm…
Stock fundamentals: Still cloudy, but less so
The same second-derivative issue is helping stocks. At the lows on March 23, the forward picture looked terrible. With the financial markets frozen and the entire economy in free fall, and the negative feedback loop between both, the bottom was incalculable. Bulls, or even those arguing to hold the line, at that point had to assert, blindly perhaps but maybe based on their sense of history, that the free fall would be arrested by the government. Absent that, the “L” scenario, or worse, looked like the base case.
Now, with our U-shaped recovery looking increasingly likely, maybe at least 80% likely, investors are beginning to look ahead, to the light at the end of the tunnel. Maybe getting back to 2019’s earnings of $167 on the S&P is actually a reasonably conservative idea for 2022, the first fully normal year we can expect. And even now, at 2,800, that’s a P/E multiple of 16.7x, far less than the 18x at which we’d been consistently valuing earnings, or the 20x we were valuing them at the old highs. And there are now reasons why the multiple could be higher, not lower: the discount rate, the 10-year Treasury, is a full 150 basis points lower than it was in the 18x P/E days. The digital revolution is accelerating. The health-care revolution is accelerating. The manufacturing renaissance in the U.S. is probably going to be accelerating…
For sure, it’s way too early to declare the Bull virus-free. Many struggles and uncertainties lie ahead. When will we get the all-clear signal on the virus front? Will a full drug-based cure be found, and better, will a vaccine be developed to prevent a recurrence? When will the economy pick up? Will the coming wave of bankruptcies of the weakened players, particularly the ones who came in with already failing business models or over-levered balance sheets, pull the rest of us into its vortex?
We don’t know the answer to all these questions. And the bears still have more facts and figures on their side than we bulls. And some kind of retest, perhaps if only to the bull’s trend line, is probably coming. All we have is our humble sense of history, our sense that there are a lot of smart people playing this chess game. That every reaction has an equal and opposite reaction.
For now, the bull remains alive and has roared back into his long-term upward-trending northern pasture. Spring is coming. Easter is almost here. And the second derivative has turned.
Hold on tight. Be Not Afraid. The path will probably get rockier from here. But there’s a light ahead, at the end of the tunnel.
March 20 2020
March 15 2020
March 20 2020