It is an occupational hazard of the investment advisory business that we are often asked whether the stock market is rational (always an uncomfortable question, but as Hyman Roth said “this is the business we’ve chosen”). The recent disconnect between the nightly news and the stock market table has never been more evident during my 37 years in this industry. The S&P 500 has now surged 43% since bottoming on March 23, including a lofty 4.91% gain last week. Whereas it is hard to justify that rally given the damage that the economy has suffered during those 10 weeks, one must keep the long run perspective in mind.
The economy grows, corporate profits grow, therefore it is rational for stock price to rise over time. The short run is driven by the fear-greed pendulum. In early March fear was running rampant and stock prices suffered their swiftest decline in history. Unprecedented fiscal and monetary programs restored confidence towards the end of March, and since then investors have been less fearful and therefore less willing to accept the 0% risk-free rate of return. Even at the current elevated 22.9 P/E multiple, the earnings yield on stocks of 4.4% compares favorably to the 0.9% yield on the Ten-Year Treasury. It is worth noting the latter yield did jump a fairly substantial 26 basis points during the week, while the dollar declined 1% and is now off 3.4% in the last month. Unwinding the extra $4 trillion of government debt could cause further declines in the dollar and increases in interest rates, but that is a story for another day (kicking the proverbial can down the road).
The news flow for the economy did improve, or at least didn’t get worse, as it relates to the headline COVID-19, China, and social unrest concerns. The big debate has been over what the recovery will look like: V, U, or W shaped? Friday’s shocking May jobs report bolstered the confidence of those in the V-shaped recovery camp. The consensus forecast was for over 8 million jobs to have been lost and the actual number was a gain of 2.5 million jobs! That margin of error was 30 times larger than any previous miscalculation. Imagine you live in Northern Minnesota and the weather forecast is for a blizzard and minus 30-degree temperatures, and instead it is 80 degrees and sunny.
The curve for the coronavirus cases and deaths continued to flatten with all fifty states having reopened in one form or another. On the international front, China indicated that it was working to implement the phase one trade deal despite the renewed tensions with the U.S., although it is widely expected that their purchases will fall short of the agreement as a result of the coronavirus pandemic. Civil unrest remained elevated on the domestic front, but the protests were largely peaceful and the debate shifted to possible reform measures.
Perhaps the glass is half full?
All the risks discussed earlier still exist. We are skating on thin ice with the pandemic, the most challenged economy in over 80 years, uncertain relations with China (as well as with pretty much every other nation), and the greatest civil unrest since the 1960s. The optimist (AKA R.J. Kuby) would reference Plato’s wisdom that “our need will be the real creator” (necessity is the mother of invention). Change is needed to address our health care, foreign relations, and our social and economic inequalities. Perhaps 2020 will mark the year where our vision improves.
On the economic calendar, Friday’s release of the University of Michigan Consumer Sentiment survey is of particular interest. A rise in future expectations would further bolster the V-shaped recovery camp.
Stocks on the Move:
What a fantastic week! In normal times we would highlight the handful of companies whose share price changed more than 10% during the week. Here are the eight that gained more than 25% last week:
APOG +27.7%, AHC +26.5%, BGSF +27.9%, SKT +43.3%, BSET +28.6%, BOOT +35.2%, PCOM +43.0%, MDP +42.3%.
The common theme is they all are economically sensitive companies whose share prices had declined over 50% over the previous six months.