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Unemployment is spiraling toward 20%. Retail sales just dropped the most on record. Global economists predict the worst recession in eight decades. And stock investors have made peace with it all.
Up 27% since mid-March, the S&P 500 on Tuesday capped its biggest 15-day run since 1933. So furious has the revival from the fastest bear market been, equity valuations are now back to where they were before it all started. Wednesday’s pullback hasn’t even retraced one day’s advance.
It’s a Wall Street adage: The stock market isn’t the economy. Rarely has it seemed more true than in the frenzied advance of the past few weeks.
“It’s just mind boggling when you consider the uncertainty,” said Ryan Nauman, market strategist at Informa Financial Intelligence’s Zephyr. “It goes away from everything we’ve learned, that markets will follow the economy or vice versa. Nobody knows when this economic data will rebound. It could be months, it could be quarters.”
To be sure, someone is always saying the market has lost touch. As incisive as the opinions sound, they are by definition minority views next to a market where millions of people are putting real money at risk. Indeed, a virtually identical bear case has been made for years about complacency among equity investors. Heeding it was an incredibly costly mistake.
Right now, the debate is intense. Pessimists are aghast, wondering what could possibly justify such a run. Believers point to unprecedented stimulus, coronavirus curve flattening, and the market’s predictive nature.
The last quality is getting an extreme test. Based on history, stocks bottom five months before a recession ends. By that logic, the rally implies a recovery taking hold at the end of August. Such a timeline might fit with optimistic scenarios of the impact of the coronavirus. But to put it mildly, a lot has to go right.
Investors and economists are in a position they’ve never been in before. Their projections are beholden to the control of a disease. The IMF’s latest forecast outlines a steep economic contraction followed by a rebound, but lays out alternative scenarios in which the virus lasts longer than expected or returns.
Wednesday showed the market is still capable of noticing bad economic news. The S&P 500 dropped 84 points at one point following awful readings on retail sales and New York manufacturing. But the retreat was barely a blip on a chart of the rally. It failed even to reverse Tuesday’s gain.
“The market is a little bit too optimistic,” Samantha Azzarello, global market strategist at JPMorgan Asset Management, told Bloomberg Television this week. “How do we recover, what are the economics of reopening a massive economy and putting people back to work? That’s where all the uncertainty, and I would argue the downside risk, is right now.”
The concept of piling into stocks at times of maximum pain got a huge advertisement during the financial crisis. The U.S. economy contracted by 8% in the fourth quarter of 2008 and 4% in the first quarter of 2009, peak unemployment was still months away, and S&P 500 earnings were about halfway through a nine-quarter decline. Smack in the middle came March 9, 2009, the start of a bull market that added $20 trillion to share prices.
Right now, the S&P 500 trades at roughly 19 times expected earnings over the next year. That’s just about in line with where valuations were before the crash began, the highest in 18 years. Valuations based on expected profits are especially risky, embedding two distinct variables: an opinion on the accuracy of analyst estimates, and an opinion of how those earnings might be valued across economic circumstances. Skeptics ask how anyone can be confident of either.
According to Lauren Goodwin, economist and multi-asset portfolio strategist at New York Life Investments, to justify buying stocks now requires an extremely long time horizon. Companies should still generate reliable revenue streams in the future, and interest rates are extremely low. She describes herself as being in the “raise eyebrows, skeptical camp,” and would be surprised if a more attractive entry point didn’t materialize.
“If you want to justify these valuations, you can’t. A very reasonable person can’t,” Goodwin said by phone. “We haven’t seen yet which sectors see heavy default rates. We haven’t seen the lay-offs of hundreds of people from places we didn’t expect them to be laid off. That’s what makes the durability of this rally questionable to me.”
One explanation for the rally doesn’t hinge on fiscal or monetary stimulus, or a quick economic restart, according to DataTrek’s Co-founder Nicholas Colas. By his calculations, if health-care companies can command a higher valuation as an essential service and megacap tech stocks continue to outperform on the basis of disruption and necessity, the S&P 500 could rally to 3,200. They simply make up too much of the market to be resisted.
Still, in the coming months investors will have to contend with or look past rough readings on the economy. It will be a bumpy ride.
“The month of March is just the beginning of this,” said Arthur Hogan, chief market strategist at National Securities Corp. “If you think the March data looks horrendous, hold my beer for April data — it’s going to be atrocious. There’s no way to get around that.”
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