Chief Economist Sees Market Dropping 30% More
Even in the best of times, there are always people who remain bearish, and during full moons like this, really come out to howl at it. Economist Charles Dumas is leading the way.
Hardly anyone would claim that we are out of the woods yet with the coronavirus panic response. As long as this continues to wreak havoc on our economy, as long as so many people are being held back from working and spending their money in the massive way that they are now, the economic problem we’re facing will only continue to worsen.
It isn’t much of a stretch for anyone to tell us that the stock market fall hasn’t bottomed yet, in spite of all the distance we’ve now put between the bottom on Monday and where we are at now, in spite of the selloff on Friday. This recovery has been driven by a change in optimism, which can be pretty fleeting at times.
There are plenty of folks who feel that the bottom of this move has already been put in. As we have discussed, the people whose opinions matter the most, the big institutional investors, have clearly changed their outlook, which is a big sign that the worst for the market at least may be over, although you never know for sure how we’ll continue to deal with the onslaught of cases.
This is far from a done deal though, and we already know how much positive news has been beaten back by the building levels of fear. That could continue to happen even though this new stimulus bill, now passed, has bolstered the bulls in a way we haven’t seen before, in addition to the other positive things we’re seeing lately.
We don’t just want to go with one side, the optimistic side, over the other, the view of the pessimists, and want to well consider both viewpoints to decide which is more likely to sway us going forward as we extricate ourselves out of this economic debacle.
Chief Economist Charles Dumas of TS Lombard has stepped up to promote the pessimistic view, expecting not only a retracement of the gains we made lately but seeing us drop a further 35% from where the market closed on Thursday, and over 30% from Friday’s close.
Economics is indeed a science, but like all science, it is only as good as its assumptions. If you base your views on assumptions about stocks that just don’t correlate with the real world, this is going to corrupt all of the data that ensues from your model. We do need to recognize the real threats, but we also need to cast off the mistaken and imaginary ones, unless we wish to be misguided.
The idea that the price of stocks is solely based upon near-term earnings is one that has infected investment thinking to the point of being a pandemic, so it’s not surprising that economists such as Dumas has fallen prey to this disease as well. It’s actually pretty amazing that so many people think this way, because it should be pretty obvious that a lot of people don’t invest for just next quarter or next year, and the time frame for investing is generally a lot longer than this.
The current situation should make this all the more transparent, as we see more and more money put into stocks, not because they feel that the companies’ earnings will be all that exciting for the next quarter or two, but because they are so well priced in comparison to their long-term value.
When someone takes a huge position in a stock today, they aren’t doing so because they think that the company’s earnings will grow in the next quarter. If you’re planning on holding these stocks for several years, at a point where we not only see prices get back to where they were, when we see earnings not only recover but continue to climb, it’s not going to matter so much that these numbers will be temporarily reduced. If we think that this is all about next quarter, like Dumas does, we are horribly confused.
This is not to say that earnings being slashed, and in some cases, turned to big losses, will not play in the markets. While this is no secret, depending on how willing we are to restore things to normal as this viral infection plays out and dissipates, there is definitely the potential for the downside from this to increase, there is more going on than this. If you can buy a stock that is only worth $50 a share now, but in a year, has a good chance to double or more, and you’re happy to hold it this long, you’re not going to worry so much about where earnings go next quarter, because this really won’t matter.
Dumas sees the recession that will result from all of this lasting “through the summer,” and while anything is possible, it is not a view that is supported by the data. This would require us to continue to restrict the economy significantly for 5 more months, which is even a number considerably longer than even the pessimists believe.
You can still find so-called experts that still see millions of deaths in the U.S. from this, or 100 million cases in the U.S., and in spite of some like the Imperial College of London now admitting how absurd this is and greatly reducing their projections from things like a half a million deaths in the U.K down to 20,000 now, some of the models out there still rely on pure science fiction to get their numbers. With only 759 deaths so far, this far into the outbreak, this 20,000 is still far too fantastic to be believed, and a tenth of this might even be a stretch.
Even though the case numbers overall keep rising, when we base our predictions on real life and not the extent of our imaginations, when we realize that these numbers don’t just keep going up forever and we reach a saturation point, this whole thing looks not so scary and actually pretty mundane, at least when you strip away the mind-boggling degree of hype that has been created by both the media and health officials.
Andrew Cuomo can continue to bang his shoe for the 40,000 ventilators he thinks he will need, projecting his state’s growth rate into the millions in his state alone, and we would need at least 6 or 7 million cases in NY to get to this threshold. The NYC area is particularly prone to this infection due to its population density than other areas of the country, but not so much that we may expect over 10 times the cases of the entire world so far this far into this outbreak,
Cuomo better hope that he is delusional because they don’t even have anywhere near close the staff to man all these machines. He is thinking that this is the Spanish flu or the Black Death but there’s no evidence that this will end up being anything more than just a minor outbreak, although you would never know this from watching CNN, who are out to paint this as if it was the worst outbreak in human history.
Regardless of what anyone believes, we are working our way through this, and while there will continue to be areas where we are revealing the true nature of the outbreak, as in the possibility of several hundred thousand people in the United States being infected, which isn’t even a noteworthy amount, there are only so many to uncover and actual growth in infections can only go on for so long before we reach the apex that has been achieved already or is near that we’ve seen elsewhere.
In Italy for instance, we’ve seen a whole week pass since they reached their apex, and while things aren’t going down much from there, they have stabilized. Cuomo’s doubling every three days only goes on for so long and not that long, but someone needs to tell him and not leave him to share his madness with his state and the world without being held accountable enough.
Once we get there and open things up again, this will not be your normal recovery, as instead of being thrown into jail by way of economic decline, this one had the government throwing it into jail, and just requires that the door be unlocked to have us recover. If anything, the lockdown can be expected to whet people’s appetites to spend in the same way as starving them for a while and then finally allowing them to eat as much as they wish.
Just a normal amount of spending will be enough though, because we were doing fabulously before all this, and this is actually a key point. If we were in the grips of a recession prior to this, and we returned back to that, we’d still be left with the task of recovering from the original problem. Right now, the lockdown is the entire problem and will be fully resolved once it is made to go away.
Stock Valuations Involve Long-Term Earnings Expectations Mostly, Not Short-Term Ones
Dumas is basing his view on his predictions that earnings will decline by as much as 30% from this, but even if they do, this does not automatically translate to a further 30% decline in stock prices, or more. We know that the drop in earnings next quarter will be a big one, but most of this at least is already priced in and even if this ends up being worse than we think, we will only drop by the difference in the outlook, not by the entire amount.
Short-term considerations such as this always compete with longer-term considerations, and with stock prices being artificially suppressed as much as they have, where long-term value has been set aside so much, our returning to our senses more will serve to expand this longer-term value focus and further dilute worries such as a temporary 30% decline in earnings.
The power of this long-term view is made particularly persuasive when we get hit by waves of panic such as we have recently seen, and we have reached the point where, in spite of how dim the near term is, the gap between how we are valuing stocks in the near term and their long-term value has become great enough that investors are finding the current situation very compelling on the upside.
Dumas also envisions a “rationing of credit” during this crisis, even though, ironically, we have never experienced a time where we have been freer with credit. What Dumas is worried about could have happened without intervention, but we have taken unprecedented measures to ensure that credit will be widely available even to those in dire straits that may have otherwise been unable to borrow what they need at rates acceptable to them.
Dumas then tells us that “P/E ratios can no longer be sent ever skyward by an ever-expanding Fed balance sheet.” This says a lot about his source of confusion, starting with the fact that he sees P/E ratios as all that meaningful in the first place. This mistaken idea also flows from the belief that stock prices are somehow determined by earnings ratios, or at least should be, given that they are clearly not in practice, and then projecting this flawed perspective into the future and continuing to insist on doing so in spite of its invalidity.
Expansionary monetary policy doesn’t ever drive up P/E ratios, and this particular comment of his is particularly confused. The idea with this policy is to drive up the E part of this equation, where the P part is always left up to the market, who take the E part into account but are motivated by what we could call long-term E, which is where we get the P part from, and which Dumas and so many others don’t account for.
We could describe P/E as merely the ratio between the outlook in the present and the future, and there isn’t even an alternative way to understand this ratio that even makes sense, even though making sense isn’t much of a requirement for these analysts. Expansionary monetary policy puts up prices by seeking to increase short-term earnings, or in this case, to mitigate the short-term damage, but whatever happens in 2020 just doesn’t play in the longer term and must be kept in perspective.
We currently have a great disparity between short-term and long-term E, and in particular, between P now and future E, where P should be if we actually focused on the long term more, which is in itself a strong force that will drive stock prices higher, and this is why the current situation is seen as such a great opportunity for so many investors. They really don’t care what happens in the next quarter, business wise, because they know we will be back on track soon regardless and will fill the gap in valuations that this panic caused.
We then will see the concerns about next quarter compete with the long-term view, where we may indeed see more downward pressure on stocks if the dips end up bigger than we are currently pricing in, but this will be opposed by a growing level of confidence that getting into stocks now represent unusual amounts of value and is what is inspiring the recovery we are now seeing.
The Recovery Will Be Stimulated as Well, Not That it Will Even Need It
Dumas even sees the recovery as being difficult because the Fed is so low on ammunition. This is his worst insight of all, because the fix is already in and the fear is that all this stimulus will end up being too much, not too little, once we get the country back to work. When the damage is intentional, when our economy has been severely quashed by the hand of government alone, unlocking the handcuffs is enough, and the stimulus isn’t in place to hasten the recovery, but to manage the current damage, although it certainly will hasten the recovery anyway.
He even sees recessionary unemployment levels as people are allowed to return to work. We will certainly need some time to get back to pre-panic levels due to some of the damage that our response has caused taking time to remedy, but given how much of our current unemployment is not structural, with the jobs waiting for all these people once we open the gates again, this is another big stretch that is not grounded in sensibility.
No one is expecting us to just turn on the lights and instantly be taken back to where we were or better, but the lights coming back on has to have a huge effect on things and no one should ever be doubting this. Earnings will take time to recover as well, as there is a lag in their reporting, as Dumas points out, but not with stocks, whose prices always represent the leading edge of the overall outlook.
The market is pretty fickle, and who knows what might happen, but our dropping another 30% just isn’t realistic based upon everything we know, and especially isn’t from people worrying about earnings being cut, because this is all very well-known already. This outlook is far from being limited to between now and the summer, as people do care where stocks may be headed beyond this point, and often well beyond it.
People like Dumas need to put a lot more thought into their views, at least as much as we are affording them here in our brief examination of his thoughts, and it does not require much expertise at all to see how flawed his suppositions are about the stock market. Amazingly though, not a lot of people understand the stock market very much, and they continue to insist that their mistaken views will come to pass in spite of their continually being wrong, clinging to their simple-minded views of how this all works and refusing to go beyond being simple-minded.
If we do get a run of panic to set us back that far, it won’t be earnings that does it, just like it wasn’t earnings that caused this in the first place, it was actually declining stock prices that commanded that we take our view off the long game and deal with the crisis before our eyes. Given that this panic selling has been so overwhelmingly replaced by opportunistic value buying lately, we will need more than one man’s confused view of things to change this.
Editor, MarketReview.com
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