Special Weekend Update, Is This The Bottom?
“Bottoms in the investment world don't end with four-year lows; they end with 10- or 15-year lows. "
- Jim Rogers
The portfolio is down -9.39% YTD this morning.
Our benchmark index, the S&P 500 is down -21.34% YTD.
Is This The Bottom?
Calling the bottom in the stock market is like reading tea leaves or tarot cards, you have to be willing to believe in the reader. Personally I'm not a big fan of these prognostications that many on TV use to draw attention to themselves. However, there is a bit of value in trying to divine the direction and levels of support and resistance at various price levels. The primary value is to see where you're at. The purpose of this exercise is to look out the windshield and try to see where the ditches are at. So, let's wander down this path and see how many rabbit holes we can stick our head into.
"The purpose in making market predictions is to look out the windshield,
and try to see where the ditches are at."
- Clay Baker
Recipe For Calling The Bottom
To cook up a stock market projection or in this case, calling the bottom in the stock market, requires some insight into what earnings will be for the companies that make up the broad stock market. Then we throw into the pot some projections made by management and analysts for individual companies. Stir that up good with some macro economics for the global economy since 40% of revenues are derived from overseas. Then fold in some U.S economic projections, along with some industry and sector projections and allow to simmer in your mind for a while. After all those ingredients are allowed to cool an investor adds a dash of optimism or pessimism and finally makes a decision.
The challenge we have today is that we don't have any idea what earnings will be. How many brick-and-mortar business have been destroyed, and how much online business has been created to off-set that destruction. The COVID-19 crisis created a self-imposed shut down of nearly all business activity globally, so where will earnings come from? Which businesses will thrive, and which ones will never come back? Asking anyone to make a projection like this is chilling to say the least. So how can we proceed?
There's some language that is forced on every investment document, TV show, financial broadcast, commercial and website, "Past performance is not indicative of future results". However, the entire investment world relies on analysis of past performance in order to project potential future results. My grandpa use to say, "You can bet on a horse by knowing how it's run". So let's look at past events that had devastating effects on the economy to see where we might end up.
Let's start with where the broad market has been and where we're at. A great tool for this is to measure the whole stock market against the U.S economy by checking the Wilshire 5000 against U.S. GDP. As the chart shows, the U.S. stock market has been overvalued relative to U.S. GDP which has now reverted to the long-term mean and has potentially opened up possibilities to selectively get back into the market.
However, the long-term outlook for the broader market remains vastly negative. Initial unemployment claims jumped in March to ~3.2 million from ~220 thousand, the biggest rate of change in US history and practically ensures we are going to have a consumption recession that could last anywhere from 3-12 months.
Additionally, the corporate credit bubble is beginning to come undone. Companies like Subway, the Cheesecake factory, H&M (and many more to come) have announced that they can no longer pay their rent, and Tapestry pulled their $700 million credit line and suspended their dividend. Retail and service companies will struggle in this environment as will anyone with weak balance sheets.
The probability that the US economy will shrink for two consecutive quarters is certainly possible, and the broader market indexes could retreat 15% - 20% from here; or 50% from the February peak. Weaker companies will go out of business or be acquired, and many industries will see a reshuffling. However, from an investment perspective, there are plenty of opportunities. Well-capitalized companies with clear competitive advantages will emerge in even stronger positions from this, even if their share price decreases in the short-term. Other companies, especially in healthcare, will thrive and use this environment to establish themselves as essential businesses for years to come.
The market predictably trades within a certain range of resistance at both the top and bottom based on its recent history. Recessions, especially deep ones with abnormal demand shocks can break the market’s bottom support, usually while investors are waiting for full clarity on what is happening and how the Fed and the Federal government is approaching the crisis.
In 2008, the normal support for the S&P 500 was ~1000. However, in October of 2008, it broke that support and proceeded to fall another 20% to ~800 in early 2009. The news was still grim at that time, but the Fed and government actions were clear and investors could see a long-term path through.
The market’s normal range of support is around 2600 for the S&P 500. However, we have broken through that already and this looks eerily similar to 2008/2009. Each situation is different, but the Federal reserve and Government actions mirror previous actions and we will reach a point where we get enough clarity from stimulus packages and their impact as well as a better timeline for getting the virus under control, at which time investors will have enough confidence that the worst is over.