The dollar started to weaken at the end of last year before the aggressive flight to quality pushed it sharply higher. We expect improving global growth will put downward pressure on the dollar in the second half of this year. Massive U.S. deficits will also act as a drag.
Valuing the S&P 500
At the start of the year, we expected economic growth to pick up modestly. The unanticipated coronavirus pandemic truncated an otherwise reasonably positive year.
When you think about the market and how it’s priced, there is no better place to look than earnings. At the start of the year, the bottom-up consensus for S&P 500 earnings per share was around $175, which put the index around $3,300. That was approximately 20x earnings on forward earnings. Now, complicating things a bit, the market sell-off started on February 20th and gave up some 33%. It was natural for investors to buy at these discounted levels.
Naturally with a economic disruption at expected earnings for the 2020 – down to $144 per share. Now, if the price/earnings remain at a multiple of 20, you would expect the S&P 500 to be priced at approximately $2,800. Well, guess where it is? On that basis, we think the market is just as overvalued here as was in February.
Our short-term perspective is limited upside, at least for the next quarter or two. A steeper decline in earnings will likely be seen in the 2nd quarter. That could set the stage for another volatile period for stocks. Perhaps an even better buying opportunity. Then, a sharp snap-back in earnings as we get into the last quarter of 2020 where we should experience rising stock prices on a weaker dollar.
It probably breaks down something like this: we think it is reasonable to expect earnings will be down 15% in the first quarter and potentially 50% in the second quarter. The third quarter should not be as bad and we’d expect earnings to improve in the fourth quarter. Obviously, all of this depends on how quickly we see the virus come under control.
How Will Markets Wrap Up 2020
The yield on the 10-year Treasury plummeted to record lows amid the heart of the crisis in March and now remains comfortably below 1%. For the moment, Inflation remains low but we could see that (finally) change as economic growth starts to recover amid record low interest rates. As economic growth starts to improve and as investors move back into risk assets, we think bond yields will rise modestly. Should the yield on the 10-year climb over 1%, that would be a sign that the economy is reaccelerating.
Oil prices turned negative in recent days – that means oil producers are paying buyers to take the commodity off their hands over fears that storage capacity could run out in May. Demand for oil has all but dried up as lockdowns across the world have kept people inside. As a result, oil firms have resorted to renting tankers to store the surplus supply and that has forced the price of US oil into negative territory. The price of a barrel of West Texas Intermediate (WTI), the benchmark for US oil, fell as low as minus $37.63 a barrel. Earlier this month, OPEC (Organization of Petroleum Exporting Countries) members and its allies finally agreed on a record deal to slash global output by about 10% – the largest cut ever in oil production. Unfortunately, it has done very little avert the incredible sell-off.
There is no question that political division has increased, even when agendas should be sidelined. Coming into 2020, it seemed President Trump would benefit from a lack of a recession and the fact that he didn’t have a significant challenger from within his own party. The “no recession” aspect obviously didn’t happen, and at this point the political environment is tough to handicap. What does seem apparent is Joe Biden doesn’t seem like a particularly strong candidate. Regardless of the election outcome, the economy was on solid footing prior to COVID-19 and we believe the current recession will be short-lived.
A major pillar of solid U.S. economic growth in recent years — is starting to falter due to the pandemic. Building permits, which are a leading indicator, peaked in January at 1.55 million units and are now down 13% (data through March) and likely headed lower. New home sales were down 4% month-to-month in February, though they were still up 14% year-over-year. Prices have not fallen, yet. Nevertheless, inventory levels are getting tighter: currently, there is a 3.1-month supply of existing homes for sale (the average range is 3.5-5.5 months), according to the National Association of Realtors. We think that on the other side of the pandemic, demand for homes — with space between neighbors and back yards — will quickly regain strength and listings will improve the limited inventory.
Similarly, getting a fragile small business back up and running requires a plethora of simultaneous re-starts. For a restaurant, suppliers who were left with spoiled produce have to be willing to extend new credit. Waitesrs who are called back may have gone off to work at Walmart. Electric, rent, insurance and other bills that have piled up are coming due. In short, all the sweat and hours behind the multiyear effort to build a business have to replicated, but within an extremely compressed period. Multiple businesses won’t make it back. And if the bottom of the pyramid is full of holes, the entire edifice can be unstable. This leads to the conversation of recent government intervention – PPP and EIDL, and more.
The recovery will be hard and possibly as painful as the pandemic. Fortunately, we live in a capitalist democracy. Rebuilding will call up human resources we didn’t know we had, and capital resources determined necessary win this war. The multiyear process of rebuilding after 9/11 resulted in a downtown New York that has never been more vital. Now, we are in the early stages of 1st quarter earnings reports – some of this news will help quantify economic challenges to come for the remainder of 2020. We encourage our listeners, clients and prospective clients to let this be a reminder that while the general stock market outlook is more positive than the broader economic outlook, the two are inextricably linked.
Huge question to be answered – Is the market blast-off mostly due to the historic government monetary and fiscal stimulus (liquidity) and less about the potential for a strong economic rebound? That’s hard to say. What we do know is that it is generally not wise to fight the Fed, the Treasury, and the full force of the U.S. government. And speaking of that, new stimulus is being approved as we speak. Paycheck protection program should see another $250 billion of lending capacity in the next few days. So, if you were considering this option, I would encourage you to be in touch with your banker to secure your place in a long line.
The Importance of Planning & Behavioral Finance
A recent study found that only 25% of Americans have a written financial plan. Yet, most people believe that achieving success requires goals and written plan for achieving them. Today, life is much more complex than it was just a few decades ago. Individuals, families, business owners….all have different concerns: funding retirement; educating children; protecting assets; aging parents; health care; transitioning the business; taxes; insurance; and legacy planning. What we have learned over the last 30 years of working with clients is what you don’t track rarely gets done. And, failing to plan invites emotional decisions to overtake your best intentions.
Behavioral finance has become a very important topic and one that our firm takes seriously. The human brain is hardwired to make decisions, and by discussing some of these behaviors we are confident it will help you avoid emotion-driven decision-making.
It starts with personal experiences and how they vary. Family, community, and societal experiences, influence our habits. Habits naturally become ingrained and influence our decisions. Let’s look at the 6 behavior types we are discussing on today’s show.
- Anchoring bias – relies heavily on information received first. Think discounted price tags.
- Acknowledge the anchor when making decisions.
- Understand, address, and remember the goal—not the dollars.
- Recognize that the ways choices are presented will affect the decision.
- Confirmation bias – seeking information that confirms our belief and desires.
- Admit that different situations call for different expertise.
- Seeking confirmation of options rather than confirmation of your belief.
- Recency bias – making decisions on recent past as opposed to looking at a larger sample of time.
- Yesterday’s truth may not be tomorrows.
- No pattern continues forever.
- Herding bias – Herding bias is the tendency to follow the actions of a larger group, whether those actions are rational or irrational. It is rooted in early
- Running with the crowd may prevent solitary embarrassment, but it won’t keep you from being wrong.
- By the time everyone is heading a particular direction, it ‘s usually time to head the other way.
- Ambiguity aversion – Ambiguity aversion is the tendency to avoid the unknown by having a preference to known risks over unknown risks.
- Goal based planning is key to success.
- Outcomes should drive your actions, not fear of the unknown.
- Myopic loss aversion – Ambiguity aversion is the tendency to avoid the unknown by having a preference to known risks over unknown risks.
- Financial losses are often “locked-in” by panic selling.
- Keep a focus on the long-term goals and make adjustments along the way.