Once a month, on the Wednesday following the 15th of the month, I will put up a long term view of the market. This is provided for investors who don’t want to trade secondary swings in the market, but would like to exit the stock market relatively soon after a bear market begins, or enter the market after a new bull market begins (change in the primary trend). In the blog, they will always have a title called “Long Term (month) (year)”, so you can use your browser “Find” function and easily find them.
The stock market has decisively broken above the downtrend that started last March, ending the bear market. The economy has been operating in an artificial state since the president shut the economy down, then began the process of re-opening. We had a two quarter recession, but forecasts for Q3 are for positive growth.
GDP – The second estimate (8/27) of Q2 GDP is -31.7% as an annualized rate.
That number is horrible, but it is an ANNUALIZED number. The number is always annualized, we just may not have realized it. So, the economy really contracted by about 8% in Q2.
The current GDPNow forecast for Q3 is +22%, which is annualized, so the quarter over quarter growth should come in about +5%. The recession is projected to have ended in Q2.
The economy is at the mercy of the virus. If we get an effective treatment that will keep people from dying, or if we get a vaccine to prevent people from getting COVID19, that will be good. Absent a treatment or vaccine, the economic performance will hinge on how well we manage the population to keep the virus under control, through social distancing, hand washing, staying at home, wearing masks, etc. The seven day average new case count in the US has come down from 46K to 35K, an improvement. The seven day average death toll in the US is 800 per day, down from 1,000 per day. This may pick back up with kids returning to school and we are entering the flu season.
There is no deal in congress on a Covid 19 Relief package #5, and they adjourn in two weeks to go home and campaign. I suspect something will get done since it appears it is needed. These things usually get done in the final hour.
The airline industry appears ready to do a major layoff in early October, as government money to carry employees expires.
With GDP projected to be positive for Q3, we are exiting the recession levels of Q1 and Q2. This is bullish for the stock market. Confirmation will not come in official data until late October.
Fed interest rates – The Fed did two EMERGENCY cuts to the Fed Funds rate in March, very unusual. The funds rate is now 0 – .25%, let’s call it .2%
This is in response to the corona virus and the two quarter recession that the lockdown caused. In addition to dropping interest rates to the floor, the Fed announced two asset purchase programs that totaled $3 trillion. Congress had provided significant fiscal support to businesses and individuals to help them get through this abnormal period, but that ended July 31. The president extended most of the federal unemployment benefit, if the states chip in part of the money.
The Fed concluded the Sept. meeting this afternoon and their dot-plot shows the Fed Funds rate at .1% for the next three years. They also project that inflation will not reach 2% for three years. Knowing this may (should) change your investing outlook. Rising rates are bad for “bond proxies” like electric utilities that have minimal growth potential but pay good dividends. We don’t have to worry about competition from bonds for a while. Take a look at XLU, an ETF for utilities with a yield of 3.5%. The risk is that if enough businesses fail due to COVID, with all those lights turned off, electric utility revenue could turn south. Nothing comes without risk.
Fed policy is strongly accommodative and hence it is bullish.
|Date||Fed Funds Rate||5 Year Treasury||10 Year Treasury||30 Year Treasury|
|2018 Year Avg||1.8||2.8||2.9||3.1|
|2017 Year Avg||1.0||1.9||2.3||2.9|
S&P earnings – The Factset estimate for Q3 earnings for the S&P 500 is -22% vs. last year.
In Q2 earnings were -34% y-o-y and the market did fine. Investors seem OK with earnings beating lowered estimates, but it leaves the market vulnerable to a correction. We just had a sharp correction in the FANG tech stock leaders and some other high flyers. The selling appears to have stopped, but could resume based on the high valuation of the market and continued poor earnings.
Earnings are poor and they are projected to remain poor for the next two quarters. That is bearish. One interpretation is that there is so much “passive money” in IRA’s and 401K’s that they believe that beating lowered earnings estimates, even significantly lowered estimates, is as good as actually growing earnings. This will keep me cautious.
PE on S&P 500 – The current 12-month trailing GAAP PE on the S&P 500 is 34, the same as last month. I used 4 quarters of earnings with the most recent being Q2 2020 (95% reported).
This metric is dangerously overvalued relative to my trimmed 30 year average of 19. I trimmed out the quarters during recessions for my 30 year average, since the P/E behaves very abnormally during those times. I go in 5 point increments for my terminology, so 20 – 25 would be moderately overvalued, while 25 – 30 would be substantially overvalued. Above 30 would be dangerously overvalued.
The stock market has moved up, while earnings have not. This is not a good development. However, it does not mean that a major downturn is near. In 1996 Alan Greenspan (then Fed chairman) said the stock market was “irrationally exuberant”, but the major downturn was still 4 years in the future.
This indicator is dangerously overvalued and bearish in this bull market.
Age of primary move, bull or bear market – The bull market is 11.6 years old. I have changed my view on the first half of 2020 decline, from a bear market to a steep correction in the bull market that started in March 2009. Yes, there was a recession (two quarters of negative GDP) and a steep decline in the stock market of over 30% from peak to trough. However, the decline was a result of artificial activity, a government imposed shutdown of the economy, and to date it has not produced a lengthy period of subdued economic activity. The pinch is very uneven, shutting down the cruise line industry and hitting airlines and hotels hard, as well as some restaurants, but other areas of the economy have been unaffected, while some have soared such as Zoom Video, Amazon, and Netflix (the “stay at home” stocks). It remains to be seen whether the residual effects of the Corona virus and shutdown kick us over into a real bear market. New bull markets do not start with the PE ratio up at 34, rather that is indicative of a bull market over-valuation (Sept 2020).
COVID-19: The northeastern states have gotten the virus under control presently. The infections in the south and western states are stabilizing.
COVID-19 Vaccine (July 2020): Moderna begins Phase 3 clinical trial of their vaccine by the end of the month and it is fully populated so readouts are expected by October. They are manufacturing and stockpiling the drug with money from the government, so if the trial is positive they can begin prioritized inoculations under an FDA Emergency Use Authorization (probably first responders first, then elderly with co-morbidity). Broader availability would probably be in early 2021. This is as good as could be expected if it stays on track to success. Astrazeneca has a Phase 3 trial underway.
Oil War (March-Sept. 2020): Corona virus has curtailed activity and therefore demand for oil. The Saudi’s, Russia, and the US have come to agreements on production cuts and the price of oil has stabilized, but at a low level of $40 per barrel (July 2020), up from the low $20 range. This remains a negative for US oil jobs, which are a significant sector of US employment.
Trade War with China (August 2020): This has percolated up again with the US forcing a sale of TikToc to US hands (Oracle). We can look for China to retaliate.
Central Banks Provide Liquidity: All over the world, banks are reducing interest rates and providing liquidity including bond purchases, helping to hold stock markets up.
Global geo-politics forces are so powerful that they are bearish. The virus is still the dominant factor, but we inch closer to a vaccine. The central banks have proven themselves effective, so the bearish forces are being neutralized.
Technically the chart is positive.
RSI at the top of the chart is neutral at 63 and moving sideways. MACD at the bottom is positive with the faster moving black line crossing above the slower moving line, and they are moving up. The price action is clearly positive, up for 5 months since the crash in March. The price action is up near the top of the range and that is a bit of a concern and bears watching.
This is bullish for stocks.
Following a two quarter recession, projections point to GDP returning to growth in Q3, so that is bullish. The Fed has short term rates near zero and plans to hold them there through 2023, plus they are buying bonds to keep longer term rates low, and that is bullish (old saying, “don’t fight the Fed”). S&P earnings for Q2 were 34% below Q2 last year and they are projected to be below last years level again in Q3, which is bearish. The PE valuation of the S&P based on the 12 month trailing GAAP number is 34, which is bearish. The geo-political factors (COVID19 virus and downturn in US oil jobs) are bearish. Technically the chart looks bullish.
By that way of looking at it, the market is neutral, three factors bullish and three bearish. A successful vaccine in the near term would brighten that outlook considerably, both short and long term.
My conclusion is that short term I am remaining cautious based on the position of the large indicators I follow, particularly the high valuation. I have been buying some index ETFs like SPY and I keep a “trailing stop loss %” order under them, like 4% down. Even the airline stocks have come up a bit, anticipating a vaccine in the first half of 2021. The outlook should brighten as long as the good news on the vaccine continues to come in.
Long Term Issues to Keep in Mind:
Federal Deficit: (Updated March 2020) – Well this is going to get a lot worse. Looks like the politicians are going to be printing money and dropping it from helicopters. But all the other major economies will do the same thing, so relatively, the dollar may not drop much (which would be bad for inflation).
(Negative – Noted Jan. 2018) It will go up despite the republicans saying that if the tax cut bill is “dynamically scored” using “possible” increases in economic activity, it will hold down the deficit by increasing tax receipts. This has not been shown to work in the past. The US added $980 billion to the national debt in fiscal 2019 (ended 9/30/2019), a tragedy in good financial times.
The total national debt exceeds $26 Trillion (late 2020), and as interest rates rise, the component of the annual budget allocated to “interest on the debt” will increase, putting pressure on existing programs, or increasing the deficit. If the deficit is allowed to rise too much in good economic times, the value of the dollar will fall and that is inflationary which is usually bad. The thing saving us today is how poorly all the other nations are managing their economies, so the dollar continues to hold up.
Rich Comeau, Rich Investing