Market Outlook

April 30, 2020

Looking Past The Abyss


John Boyd

Stop me if you’ve heard this before: The economy is really going to get crushed. The initial estimate for first-quarter GDP just came in at -4.8%, and since that only included about two weeks or so of the mandated shutdowns, the second quarter promises to be far, far worse, perhaps on the order of a 30%-plus decline.

So why isn’t the stock market in a free fall?

Because the stock market is not the economy.

This is a critical point. Firms that offer online services or are technology disruptors — which are holding up relatively well — make up a bigger part of the stock market indexes than they do of the economy, while the opposite is true for hard-hit restaurants, retailers and leisure firms. For example, information technology makes up 25% of the S&P 500, but only about 5% of GDP composition!

Even more important, however, is that the stock market is a forward looking, discounting machine.

If you know the economy is going to get walloped, and I know the economy is going to get walloped, you can bet that a lot of the economic damage to come has already been discounted by the market. For example, on March 26, when initial claims for unemployment first spiked from 251,000 to 2.9 million, the market rose 6.2%! And when claims jumped to 6.0 million the following week, the market rose again, this time by 2.3%. Clearly the market had already “priced-in” the unprecedented climb in unemployment.

Similarly, a lot of bad news for corporate earnings has been baked in as well. Since the beginning of the year, earnings estimates for the first quarter of 2021 have been sliced by over 20% and second quarter earnings forecasts have tumbled by more than 30%.

In fact, I would argue that to a significant extent, the market is actually looking across the abyss that is 2020, and focusing instead on the other side in 2021.

If that is the case, then the current economic data coming in would have to be much worse than expected to have a significant negative impact on stocks.

What will be much more important then, is any data that sheds light on 2021. And that largely means the progress against Covid-19, how soon restrictions may be lifted and businesses allowed to re-open, and importantly, how consumers will react to those businesses — with open arms or with trepidation.

Take the aforementioned GDP figure for the first quarter, for example. The 4.8% contraction — the worst quarter since 2008 amid the financial crisis — was worse than the expected 3.8 to 3.9% forecast by economists, but not hugely so. The market responded by rising over 2% on that day. Why? Because there was some very modestly encouraging news about the first phase of clinical trials for Gilead Sciences’ drug Remdesivir to treat those infected by Covid-19.

States Start To Reopen

As I write this, eight states have begun easing restrictions and letting some businesses re-open and seven others where restrictions were set to expire on April 30. We can debate whether or not these actions are wise or warranted. But at the very least, watching them will give the rest of the country some information about whether Covid-19 cases will spike higher (they seem likely to be higher, but how much so is key) once restrictions are eased. Realizing, of course, that there is a huge difference between dense urban environments and more loosely populated areas, so what works in Montana may not be good for New York.

And we will also get a read on how soon (or how much) consumers will return to their previous habits. It seems unlikely that they will act as if nothing has changed, so spending is likely to be subdued for some time. (If they announced that the Red Sox season was opening tomorrow, I don’t think I’d rush over to Fenway Park!) On the other hand, spending has been curtailed during the shutdown, so there may well be a good deal of pent-up demand.

Much Remains Unknown

There is still much we do not know about the virus. Do the antibodies produced in infected persons who survive mean they now have immunity? And if so, for how long? Will the virus be worse this winter with a second, more deadly, wave of infections like the Spanish Flu? (One thing we are learning is that this version of the virus is very likely far less deadly than initially presumed — more inline with the common flu — as multiple studies have shown that the actual infection rates are orders of magnitude greater than the reported figures, so death rates are lower.) Will we develop effective treatments or, even better, a vaccine in the near term? There is no guarantee of either option, of course, but there are several well-funded efforts underway — even the redoubtable Dr. Fauci is “cautiously optimistic” that a vaccine will be found by winter.

Stay Calm And Stay Invested

Don’t panic and dump your stock funds over what are likely to be truly horrible economic data in 2020. Look instead at how the outlook for 2021 is developing. There are downside risks to be sure, but there are also "upside" risks that should give pause for those who sell now. Some of the biggest moves up occur when things appear darkest.

 — John M. Boyd