As the U.S. earnings season got under way last week with the largest banks reporting Q1 results that painted a dismal picture of the U.S. economy, stocks continued their remarkable rally off a low reached on March 23. The 7 banks reported so far have set aside a massive $27 billion in reserves for loans likely to go delinquent as a result of the pandemic bringing the U.S. and global economy to a standstill. This is consistent with the ugly U.S. economic data that have been reported recently which show some of the worst employment and retail sales data in history.
Despite all of this bad news, the S&P 500 has rallied over 25% in the past four weeks after declining by -35% in the four weeks prior. The impressive rally has caused head-scratching and inflicted a lot of pain on many investors as few have believed in the strength and durability of this bounce in stocks. The consensus isn’t always wrong, but the April Bank of America Global Fund Manager Survey shows extreme investor pessimism with professional investors holding average cash balances of 5.9%, the highest cash balance since the 9/11 terror attacks. No doubt short sellers have been hurt in this current run-up that have caught many investors offsides and bearishly positioned. How do we reconcile this strong rebound in stocks with such awful fundamentals in the economy and in corporate results?
This brings to mind the old Wall Street adage: the stock market is not the economy. While value stocks, which comprise of “real economy” companies mostly in cyclical sectors like Financials, Industrials and Energy, have suffered much worse in their price declines compared to the market, growth stocks like Amazon and Netflix have actually raced past their previous all-time highs. Investor psychology has also trumped fundamentals in influencing stock prices during this turbulent period. Investor sentiment has swung wildly from extreme fear to optimism in coming to terms with the human and economic costs that a novel coronavirus has inflicted. We saw dislocations in many asset classes in March, but the U.S. Federal Reserve acted quickly and decisively in reviving Quantitative Easing measures, which suppressed volatility in bond and stock markets and allowed risky assets to find their footing.
Stocks closed last week on a positive note from excitement over a report of Gilead’s promising COVID-19 treatment drug and from new federal guidelines on reopening the economy. Even when the economy is reopened, the grim business reality is that it will take some time for companies to return to normal after lockdowns end. A recent survey of CFO’s conducted by PriceWaterhouseCoopers showed that just 22% of those surveyed said it would take less than a month for their companies to return to normal compared to 66% in a survey taken on March 9. This could foreshadow the earnings guidance coming this earnings season. Realistically, the upcoming earnings reports are likely to emphasize the uncertainty rather than certainty because investor and management visibility into the near term economic prospects is poor.
Lastly, the stock market is an excellent discounting mechanism. Historically, stocks have anticipated a bottom in economic growth about 5-6 months before the end of a recession. If March 23rd did mark the low in stocks, it follows then that the stock market is currently anticipating a low point in economic growth and a recovery some time in August. While I believe the stock market has sufficiently discounted the severity of the recession, time will tell if it has also discounted correctly the length of the recession.
Lieh Wang, CIO
iA Investment Counsel Inc.
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