Please note that, while monetary issues and considerations pale in comparison to the human toll that the coronavirus pandemic has taken, this commentary addresses the investment impact the virus has had – and is having – on the markets. We feel for and wish those having to face the effects of the virus the best of luck and a speedy recovery.
At various points over the past few months, COVID-19 has caused many to wonder whether the economy was on life support. The markets experience downturns periodically (though not typically as the result of a pandemic), and these lean times usually don’t necessitate “lifesaving measures” being enacted. Our economy has faced two serious crises over the past 12 or 13 years, but has continued to chug along, and despite recent hardships, promising signs have begun to emerge. Here, we will look at a few such signs, as well as address some questions that only time will be able to answer.
The markets reached new highs in February (yes, just three short months ago), saw the floor drop out in March, recovered strongly in April, and continued the recovery process in May. Stocks have continued to rally, while bonds have advanced at a more measured pace. All major equity averages saw strong gains. Unemployment, while still horrific, has stabilized, and inflation has remained subdued. While the economy may not be experiencing a V-shaped recovery, the markets, to some degree, are. Remember, the markets tend to be forward-looking, and investors are casting a hopeful eye on how the economy might fare once the virus is largely in the rear-view. (Remember, too, that the data changes on a daily basis, and much of the information contained herein may be old news by the time you read it.)
While the markets are recovering, questions are being raised as to whether the rally is sustainable. Are the markets ahead of themselves and overvalued? Is there another sell-off coming? How will things behave should there be a second wave? Several data points suggest the recent uptick is no flash in the pan. Things like rail freight (up 3.2% since April), hotel occupancy (up 9.0%), gas purchases (up 27.8%), and air travel (up 100%+) are all moving in the right direction, though they remain substantially down on the whole. Unemployment claims are astronomical, but have stabilized, and even shown some slight signs of improvement. If these data points become trends, the rapid growth that has been forecasted for later this year and into next may yet come to fruition.
Historically speaking, the markets are trading at a high-earnings multiple (20X+), though this is a different animal right now. There is not a lot of comparable data that can be used as a guide, though it can be determined from where some of that multiple originates. The price-to-earnings ratio for the S&P 500 is 21X+; for big-tech companies, it is 27X+, or about a 28% premium. So what? Earnings multiples for big tech are always higher than those of the market as a whole. The issue here is what is causing the S&P 500 ratio to trade where it does, and the answer lies in those same tech stocks. Since they comprise almost 25% of the valuation of the index, the excess valuation is largely due to just a handful of stocks that normally trade at higher multiples. This could be discouraging, but look closer and the data becomes more intriguing. The large tech stocks are trading at lower multiples than at other points in time (anyone remember AOL in 1999?) and continue to grow at a rapid pace. The remaining stocks in the index (and the stock market as a whole) still have room to grow; their earnings will recover, but at a slower pace than the tech stocks. That should provide some downside protection to the markets.
Regarding both a potential sell-off and a second wave of the virus, there’s no predicting how things will play out. However, there are some things worth paying attention to. The market has rallied and the broader economy (outside of tech) is facing large hurdles in regaining its feet. Restaurants, retail (especially brick-and-mortar), hotels, airlines, cruise operators, and auto manufacturers, among other sectors, may not feel any sort of recovery for some time, although there is a lot of pent-up consumer demand – one need look no further than cruise bookings, which in some instances are up over 600% compared to prior year. But what if the rally in tech stocks fades and drags the market down with it? While unlikely, that could cause investors to pause their buying and run for cover, resulting in a further delay in expanding gains to other sectors.
Will the trend toward working from home ultimately mean lower productivity? That depends upon how well people adapt. Waning productivity levels may worsen, although returning manufacturing to the U.S. may help. A declining productivity number would lead to a declining (or slowing) GDP, translating to a longer horizon to return to where things were, pre-pandemic. If there is another wave of the virus that could trigger a sell-off, but encouragingly, the data, at this point, does not indicate a large second wave domestically or internationally (including countries that opened up much sooner than the U.S.). Also encouraging is the fact that much of the talk of a second wave seems to focus on late fall or winter, versus this summer. While threats remain and no one wants to get ahead of themselves, the questions and concerns surrounding the future seem somewhat less daunting than they were only a month ago.
One further, very encouraging sign, both for the markets and the economy as a whole, is that savings rates have gone up dramatically, as there have been fewer opportunities to spend. This hurts the economy in the short run, yes, but in the long run, that cash will likely be deployed and/or invested in the markets. Where has the cash come from? Less spending, first and foremost, but also the fact that many workers that have been furloughed or terminated are now receiving nearly as much in unemployment compensation than they were from their actual paychecks. This must be a short-term effect, or the economy will face other dangers, but for now, the excess cash is helping. Also, the stimulus payments have provided some relief, as has the PPP loan program. Home refinancing due to the collapse in interest rates will ultimately benefit the economy, as it helps free up discretionary spending. All of this serves to affirm economists’ predictions of sharply higher growth later this year and into next.
Our approach has not changed as we continue to seek out opportunities that provide a balance between protecting the downside while looking for opportunities to grow. We are here and available to discuss your portfolio or any other issue you may have. Please contact the Wealth Management department at (608) 826-3570. We look forward to speaking with you.