Monthly Market Muhsings - June 2020
Markus Muhs - Jun 30, 2020
A very brief recap of the markets in the first half of 2020.
The second quarter of 2020 is now in the books and it probably warrants some mention in the stock market history books. After an unexpectedly horrendous Q1 this year, Q2 included the bulk of the March 23 to June 3rd span that was labeled the strongest 50-day rally in the history of the S&P 500.
With the COVID-19 pandemic ongoing and the noisemedia again threatening us with stories of increasing cases and hospitalizations in areas where the economy opened “too early”, and many parts of the economy still effectively shut down, it’s hard to understand why the market has been doing so well and why the major indexes are a stone’s throw from their all time highs. The Nasdaq even broke though the 10,000 mark in June and set new all time highs, if you can believe it!
Truth is, it’s often hard to understand market valuations; now more than ever. In years past, when the economy was humming along, uninterrupted by health pandemics and shut-downs, analysts could make forecasts on the market such as “S&P500 earnings are expected to be $150, so with a 20x price/earnings multiple we have a year end target of 3000”. Such forecasts are never expected to be hit bang-on, but were grounded in factual data and were usually only off by a few degrees of multiple, with earnings fairly reliably hitting their targets, but market sentiment being the unpredictable factor. It was a matter of whether the market was extra bullish and applied 22x (S&P=3300), or was swayed by some bad news and applied an 18x multiple (S&P=2700).
Today, the Novel Coronavirus, along with central bank and government actions, have introduced an enormous amount of unpredictability into market valuations. In terms of earnings, the general consensus is that they’ll be awful for 2020 but will rebound sharply in 2021, thanks to not only a reversion to the mean (of consumer/business spending) but also a snap-back of pent-up spending (ie: deferred vacations or other deferred spending that’s being replaced by historically high savings rates currently). A lot of this depends on how long the pandemic lasts though. I mention the central banks and governments because of the fuel they’ve added to the fire to keep it going, which I believe (based on my market update last month) is already creating inflation in the form of security prices (stocks and bonds) and will eventually lead to general economic inflation.
In the short term stock prices can go either way, and I think they can go either way by a fairly substantial margin. In the price/earnings equation, the denominator will undoubtedly be significantly impaired over the short-term. The multiple, which in turn leads to the price that the markets apply to stocks, is a complete wildcard, whether it be pessimistic over a second wave of COVID causing a re-closure of much of the American economy, or whether asset price inflation and the general “animal spirits” take over, or FOMO for all those sitting in zero-yielding cash, leading to stock prices that are wildly overvalued relative to fundamentals. In the longer term though, when we return to more normal conditions, we might expect more normal market valuations.
I don't often put a lot of weight on market forecasts, but Capital Group's annual and midyear outlooks are second to none, mostly because of the fantastic infographics they do to show us the current state of things. Obviously, if you look back at their 2020 outlook piece from December, I don't think they could have predicted a single thing that occurred over the past 6 months. Still, these are educational and enlightening: Capital Group Midyear Outlook.
Bottom line, as we go forward, is that I can only predict that there will be a ton of noise in the news and in the markets in the short-term. Markets will always over-react to news, good or bad. In the mid-term we'll get through this, the virus will be eviscerated (or science will render it insignificant), and the economy and markets will resume the long-term upward trend that in the past survived every war, pandemic, or economic catastrophe that was thrown in its path.
Investment Advisor & Portfolio Manager