Fear Factor

Fear factor.  Stocks had a mixed close yesterday as investors were concerned that a "second wave" might not be so good for the economy.  Deeper losses earlier in the session gave way to later session buying because it is hard to hold back market optimism, even though it may be unfounded.

N O T E W O R T H Y

Lockdown 2.0?  That is how the market works.  We are still in the midst of the first de-facto national lockdown and investors are already starting to ponder a second lockdown.  “Wait… what?”, you ask.  First of all let’s get something straight, there is no actual executive order forcing Americans to stay at home. Shelter orders are governed by states, though most people tend to check into the Whitehouse briefings, save New Yorkers who tend to opt for their Governor for information, forgoing the President and New York City’s Mayor.  The Federal Government has set suggested guidelines for restarting economies leaving the ultimate decisions up to the states.  All of it is rather tricky, but States are really ultimately responsible for the level of lockdowns.  In case you haven’t noticed, more and more states are beginning to ease sheltering restrictions, some clearly in a more responsible manner than others.  But at the end of the day, the people themselves are responsible to abide by the rules and, as you may have also been noticing, people are getting a little more “adventurous” as they tire of the seclusion.  Grocery stores are becoming a bit more populous with shoppers while parks and outdoor venues appear to have sprung back to life with adventurers who seem to be rounding down in their six-foot distancing estimations.  States are having to weigh the economic costs of the economic pause with the wellbeing of their citizens. Many of those citizens are increasingly eager to get back to normal, earn an honest living, and maybe have a walk in the park with family.  We all know by now that “normal” will only come once a credible arsenal of therapies are available to prevent and treat the virus.  The most optimistic estimates seem to be zeroing in on late 2020 for availability.  Keeping current lockdown conditions until the new year is not only impractical from a social standpoint, but also an economic one, as the massive amounts of Federal stimulus can only carry the economy so far.  You are probably wondering why a market note which is supposed to be espousing economics and finance is talking about all of this lockdown stuff.  That is because this is exactly what is on the mind of institutional and professional investors.  Eager to get the economy back on track while fearing that if it happens too soon things can get a lot worse.  Dr. Fauci and a number of experts are due to address lawmakers today and he will stress that if social distancing conditions are eased too quickly, the country could see a resurgence of new cases causing unnecessary deaths (he emailed his comments to a reporter, WHILE YOU SLEPT). There are some signs of second waves in Germany and South Korea, two countries which were credited for early containment success and also some of the first to ease restrictions.

There is some math behind all of this.  I have written quite a bit recently about notably high stock valuations, and I am not alone. There are many different methods to determine stock valuation and the most common one is PE, or Price to Earnings.  Historically, the S&P500 traded around 15 times its earnings per share.  The multiple grew steadily after the last recession and was further fueled by the 2017 tax package hitting a recent high of 23 in 2018.  With tax benefits wearing out and the onset of the trade war, company earnings growth began to slow causing PE's to dip to around 17 in late 2018 (still high based on historical valuations) when the Fed shifted to a dovish stance sending stocks, and multiples up through 2019 and they ended that year with a PE of 21.  High PE’s are not necessarily bad when growth prospects are high. Turning to the current year, PE’s hit a low of 18 when stocks sold off in March and have since climbed back to 22!  In the midst of a pandemic and economic crisis.  If we look at PE’s based on expected earnings for next year, we see similarly high levels, indicating that traders are ignoring 2020 and pricing in a recovery for 2021.  As the nation slowly lifts restrictions leading into what is a historically weak time of year for stock markets, money managers are increasingly uneasy about the potential for a second wave of COVID-19 which could lead to another lockdown. With high valuations and expectations baked into the market, a resurgence could prove painful for stocks.

THE MARKETS

Stocks started yesterday’s session weak on as investors considered the benefits of unlocking the national lockdown. Later in the session buying paired losses for a mixed close.  The S&P500 rose by +0.52%, the Dow Jones Industrial Average fell by -0.45%, the Russell 2000 slipped by -0.63%, and the Nasdaq Composite Index climbed by +0.78%.  Bonds fell and 10-year treasury yields climbed by +2 basis points to 0.70%.

NXT UP

- This morning, the National Federation of Independent Businesses released its Small Business Optimism (April) which beat estimates and came in at 90 compared to last month's 96.4.

- Consumer Price Index excluding Food and Energy (April)  is expected to come in at 1.7% year over year compared to last month 2.1% reading.

- The monthly Budget Statement (April) is expected to show a -$737 billion for months compared to last month’s +$160.3 billion surplus.  Not a pretty number but not unexpected either.

- Fed Governors James Bullard, Neel Kashkari, Patrick Harker, Randall Quarles, and Loretta Mester will all speak today.

- The Federal Reserve will start buying bond ETFs in the market today as it puts some of those Federal Stimulus dollars to work. This is a first of its kind.

- This morning Duke Energy and Ingersoll Rand missed earnings.

daily chartbook 2020-05-12