Is the New Bull Market Here?
Since my last time with you, a lot has happened regarding the stock market and much of that on the surface does appear to be bullish. Bullish simply means that the stock market is rising and is expected to continue rising. We have seen the stock market make an unbelievable rebound since its market lows on March 23rd. Last week we finally saw the S&P 500 break through the 200 moving day average after weeks of stagnation. As a result, many are asking “ is the bull back and is it now a buyer’s market?” Based upon what we see and know, I would say not quite yet.
I want to spend some time to help you understand where we are regarding the economy and the stock market and how that could potentially impact us in the short run. There seems to be a significant disconnect between the stock market and reality. The stock market is significantly overvalued currently. The P/E (Price to earnings) ratio of the S&P500 at the end of 2019 was $140. This measures the value of the index versus its earnings. Current P/E ratios stand at $182. This means the market is overvalued today compared to December. Normal PE ratios are around 116. Seems hard to believe when we think about where current corporate earnings stand. Eventually, this disparity will need to be reconciled and for that to happen, earnings must increase or values must decrease. Increase in corporate earnings in the short run seems unlikely, so we know the alternative.
Market index performance is also extremely concentrated. There are 5 stocks who are responsible for 20% of the overall return. This indicates weakness among the vast majority of the other companies that comprise the index. The last time we saw indexes this concentrated was in the 70s.
Weakness is also apparent in the overall economy. Q2 GDP is estimated to fall to -30%. Currently, over 40 million Americans have filed for unemployment during the pandemic. Goldman Sachs predicts we could see unemployment numbers of up to 25%. Federal Reserve Chairman Jerome Powell has said that 40 percent of U.S. households earning less than $40,000 a year lost their jobs in March. A May 15th article from the University of Chicago (Becker Friedman Institute) cited that 42% of recent layoffs will result in permanent job loss. It is nearly impossible to wrap our heads around what these numbers mean and what the impact will be on our country’s economy. We also believe this is not the end of the bad news, but rather the beginning as the impact of the shutdown is just now starting to be understood.
So, what gives? Despite all we know currently, and what we are expected to see in the future, why does the market continue to ignore all the bad news and just keep climbing? I believe the market is currently “riding on hope”. It is pricing in an absolute best case scenario that involves America quickly getting fully back to work, recovering lost earnings, GDP rapidly rising, having a vaccine by end of the year, and that there will be no secondary COVID-19 surges. Essentially, we have priced in a perfect recovery story, leaving no room for disappointment. There is a current disconnect between what investors expect and what is reality. We simply cannot continue to completely ignore the current technical and fundamentals of the market forever. Long term analysis shows us that eventually these matters will have to reconcile. When that happens, the market could have their day of reckoning.
What does this mean for investors? Our investment committee, has decided to begin taking fixed income positions inside our portfolios very shortly. Our relative strength indicator is now showing there is a good opportunity in this space. However, we believe that the risk remains higher than the potential reward and believe the better opportunity to increase equity risk will come later this summer. We will continue to follow our math and rules-based program to guide our investment decision making process. We are hopeful that we will soon begin to re-enter the equity market tactically. We will include asset classes and sectors that show positive relative strength and believe there will be tremendous opportunity when that happens. We just are not quite there yet. We continue to choose safety for our clients as hope alone is not a prudent investment strategy. As Charlie Munger once said “The big money isn’t made in the buying and selling but in the waiting.”
If you would like to follow our weekly video series where Ashley will be discussing the current market and pertinent economic updates, please follow us on Facebook. Please stay well and if you have questions about your current portfolio mix given these extraordinary times, we would love to have a conversation with you.
Ashley Rosser AIF BSN