Are We Headed for a Second Round of Market Panic?
Scott Minerd of Guggenheim Partners is sounding the alarm. We’re about to open Pandora’s economic box, and the worms we see may set off another round of panic.
While stock markets have stabilized from the beating that they took over pandemic fears, and we’re even seeing the outbreak situation start to stabilize as well, not everyone is feeling all that comfortable with the situation right now.
There is more to come in this drama, the story that gets told when we finally face how much damage we have done from our efforts to stem the growth of this particular virus. Appropriate or not, in good measure or not, we are going to have to face the reality of this mess soon, and this is a story that is far from over as the restrictions continue in full force and we’re not even sure when this will end.
Even when the green light is given to start to resume normal life once again, we will probably not go from lockdown to wide open straight away, and it may be prudent to take a more gradual approach to ensure we don’t start this whole thing over again. Some of this may come from public officials, and some may come from the lingering reluctance from consumers that may persist in some form long after the outbreak has peaked.
President Trump is starting to chomp at the bit in his calls to “open the country again,” but he only can do so much on that side of things, as these restrictions have been put in place by the states and this is primarily within their jurisdiction. The federal government only regulates intrastate commerce and these restrictions are on the interstate level, which the Constitution reserved for state governance.
Meanwhile, as we wait for this, the bill keeps getting bigger and bigger by the day, as does the hardship that people are facing. There is an unexpressed motivation at the grass roots level to get back to work and to get back to normal lives that has been set aside for the most part for now, but is festering behind the scenes and will push itself more to the front of the line of concerns as the virus fears die down more and more over the next while.
While some may think that the market has already priced in all of this in its decent, where we now are seeing the light at the end of the tunnel and we have taken some of that projected damage off of the table, markets can only price in what is known or estimated and we really don’t have all that good of an estimate of the economic cost of this war as it continues to rage on.
Stock markets can also get pretty spooked and overreact, and we have seen plenty of that lately, with the wild swings we have had, especially the ones down. What markets really don’t like is uncertainty, and while things remain fairly uncertain, they aren’t as uncertain as they used to be not that long ago, especially with those who have relied on predictions that had us thinking that this was much bigger of a crisis than it was, with millions of deaths in the U.S. and so on.
The latest prediction sees us with 81,766 deaths from this, and we should expect that this will continue to be downgraded as we are seeing the actual numbers come in considerably lower each day. On April 6, for instance, this model has predicted a total of 12,539 deaths, with the actual number coming in at 10,871. The reason is that we are starting to level off more quickly than the model predicted, which sees the death rate almost tripling over the next 10 days, but we’re not seeing that happen at least yet and each day now we’re rising more slowly than predicted.
This is all good news, and if this trend continues, this will allow us to get back on our feet more quickly, but then we have to wait for the economic side of the story to be told more, and this is what is still scaring some investors.
Scott Minerd, global chief investment officer for Guggenheim Partners, is among those who remain quite concerned, and envisions the S&P 500 dropping to as low as 1500. This would involve not only giving up the gains that we have put in since the bottom on March 23, this would see us drop by 44% from where we closed the day on Monday and 32% below the low water mark so far of this bear market.
Minerd isn’t saying that we will necessarily go quite that low, and sees this as his worst-case scenario, but he does see a very big drop in our future, due to his concerns about how we will view the battered earnings reports that are to come soon.
Minerd believes that “when the markets start to see some of the data on unemployment rising and economic growth and corporate earnings contracting, there will be another level of panic in the market.”
There are actually two parts to this that we need to separate, the panic part and the part that is using this data to price stocks. We never want to discount the effect of panic on stock prices, as this can be an overwhelming force, as recent memory will attest to. This is the real beast during times of uncertainty, where people not only sell due the sheer power of the stampedes that these things cause, it actually makes perfect sense to regardless of where you think things will move to in the future.
If you hold a stock that was worth $100, and you know will trade at $200 down the road, but you know that right now it is going to go a lot lower than $100, the right thing to do is to sell it and look to get back in when it takes the hit we expect, at a lower price.
This is where selling into the trend factors in, and this goes on all the time on multiple timeframes, but there is a level of selling pressure that applies to all timeframes, including the longest ones, because even if you want to be in a stock in 2030, whether you should be in it in March of 2020 is a separate question. Those who do perceive this put themselves in a better position to not only limit their losses from these moves, but to profit from them instead if they are wise.
Where Stocks are Going in the Longer Term Has Nothing to Do with This Virus
If this is what was scaring Minerd, it would be hard to disagree, and the advice here would be to keep a close enough eye on things so we don’t get caught in a move like this, where if things start to pick up that much on the sell side, we can be ready to step out of the fray and let others lose money while these things are going on.
We don’t really know enough about what to expect to want to miss out on whatever rallies happen while things are more settled down like they are now, and Monday’s rally is just one example of this. We don’t want to be fighting monsters that have not appeared yet, and just end up swinging at air and pulling a muscle in the process, as popular of an idea as that may be.
It turns out that Minerd’s concerns are more about how the earnings reports are going to affect things, and he is looking to combine his predictions about where earnings are going in the short term and using a traditional price to earnings ratio of 15 to get his numbers, but we need to be careful with thinking like this.
We should know that, while earnings do influence stock prices to be sure, people do not invest in stocks just to capture the next few quarters of earnings. When we seek to understand stock prices in relation to earnings, we need to understand that it is not just the next quarter that matters, it is all those future quarters and years to come.
More recent earnings reports do bear a little more weight at times than ones far off in the future, but this is only due to their predictive value, not boding as well for down the road, not because earnings are terrible now but for reasons independent of business circumstances normally, when you try to shut down the economy as much as you can as we have done recently.
We do know though that what a company makes or does not make in the next quarter or even in 2020 is not all there is to know about the long-term value of a company or stock, but this is just the way a lot of people want to understand stock prices. Such a view is particularly unilluminating in times like this, with the numbers being driven down not by organic business performance but by way of this economic vacation.
If the earnings losses were organic, we’d still want to look to the future to obtain perspective, where if things were set to improve in 2021 and 2022 and beyond, we still won’t be too bothered by the lower numbers that we are facing temporarily.
When we ever seek to understand the value of a stock by just looking at its near-term earnings, this surely isn’t what stocks are all about. We make two major mistakes with this, just focusing on what is in front of our noses, these upcoming earnings reports, and not only using this to value the stock overall, but to use a ratio that is the product of the circumstances at any given point in time, not the driver of them.
What these ratios tell us is how much a company or the market overall is priced in to grow when we use earnings as a benchmark. If the price of a stock is 15 times its current earnings, if we are using a fundamental approach, this means that the market has valued the future revenue stream by this much. Some companies are worth higher multiples of their current earnings, and some are valued lower, and all of this is done at the market level which becomes expressed by how much the market wishes to pay for a stock.
We cannot just pick a historical average such as 15 and assume that this is what the market will decide to value stocks at, even if we are fundamentalists, those who insist on understanding the price of stocks based upon business and economic data. If that were the case, if the S&P traded on another planet at a constant earnings per share ratio like 15, this would constrain prices, as people could buy and sell their shares on the other planet if we got out of line on one side or the other.
We do not have such a thing, outside of the imagination of a lot of analysts at least, and this ratio is instead just a reflection of the mood of a market at any given time when we’re talking about market ratios, and the mood with a stock when looking at individual stocks.
If We Invest Based Upon Earnings, We At Least Need to Look at the Big Picture
As we see earnings get slashed, we won’t really be thinking that this is all there is, as we will expect these companies to get back on their feet in the same way that we expect ourselves to do. A lot of investors won’t even worry about what is going on now, because they plan on holding their stocks for quite a while, when earnings are expected to be much better and that does certainly factor into stock prices quite a bit.
This does not mean that these grim earnings reports that we are about to receive won’t produce downward pressure on stocks, and maybe even cause a little panic for a time. This is the other side of the matter, the technical side, the side that has people look to time their positions independent of what the longer-term view may be.
Those who pay attention to these things will look to see where the market is moving, and if they see it dropping due to fear as it did a few weeks ago, or for any reason as the reason doesn’t just matter, just the move, discussions of where earnings will be next quarter, next year, or next decade are all moot points, as they are looking to avoid getting trampled on right now and use the drop in prices strategically, to be out for a lot of the drop or even ride it down on the short side, and then get back in when it is over.
The market continues to remain pretty volatile, where both our up days and our down days remain of epic proportion. Moves of greater than 5% during a single day are rare, but these days, they are commonplace.
In such a volatile environment, we may well expect that there will be some bad news that jolts us downward, and while we may wish to sidestep these moves if we are adept enough, few investors really have the skills to confidently trade these moves, to be in and out of their positions often enough and quickly enough to take advantage of these back and forth moves.
However, when the mood decidedly turns, like it did back in February to the downside, and more recently to the upside, this is something we all can use, and if we do see another reversal like this, we may wish to act.
This rally has been based not upon next quarter’s expectations, but expectations further out than this, when all of this is long behind us. This is what is behind the upward turn that we have seen, the fact that investors saw a lot of value with the depressed prices that we saw, seeing how much of a bargain these stocks were compared to where they will be once we all return to good health.
They aren’t forecasting 2020 projected earnings, and then multiplying by some magic number such as 15, and deciding that we are instead headed for a far bigger bear market than we thought. If all of this big money did think this way, then such a thing would happen, because there wouldn’t be anywhere near the buying interest as there has been or is and the fear that is surely to show its ugly face again would reign again as unopposed as it did when this all started.
We need to take warnings such as those from Minerd seriously enough, but at the same time, if we do want to be fundamentalists, we at least need to focus on the fundamentals that really matter, which involve far more than just looking at the earnings calls that are looming.
If we are only playing short-term, as traders do, the short-term game is going to matter, although traders don’t care at all about fundamentals and will just follow the crowd where it leads. If we are focused long-term, we need to be careful to avoid having short-term concerns impact our strategy very much, and investing based upon fundamentals requires that we look as far down the road as we can, further than just the 6 feet that we’re supposed to keep away from each other now. There’s a whole world out there beyond what is right in front of our faces.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
Topics of interest: News & updates from the Federal Deposit Insurance Corporation, Retirement, Insurance, Mortgage & more.