by Shawn Narancich, CFA
Executive Vice President of Research
Finding a Bottom
As the world’s battle against coronavirus rages on, we offer our best regards to those on the front lines battling the pandemic and express our sympathies to those whose health and welfare are being directly impacted. Meanwhile, the stock market rollercoaster continues. Extreme volatility that saw the S&P 500 average 5 percent daily moves in March finally concluded an exhausting quarter that marked 20 percent losses for the blue ship index. In the newly begun second quarter, investors remain challenged to see past the forced economic shutdown to better days that lie ahead for the economy and stock prices. Currently reported economic data is just starting to reveal economic impacts of the virus-induced shutdown.
Predictably Ugly
Following a record surge in unemployment claims to nearly 7 million in the past week, investors saw the first glimpse of how bad the payroll data is about to become. As the chart below shows, the reported loss of 701,000 net jobs in the month of March is the worst labor market report we’ve seen since the waning days of the global financial crisis 10 years ago. Not surprisingly, travel and leisure industries bore the brunt of job losses.
Source: Refinitiv
Darkest Before the Dawn
As bad as the economic data is and will continue to be for some time in this unfolding recession, history shows that stocks have historically bottomed before the end of such economic contractions. The chart below shows the U.S. history of recessions/depressions by length, and how far along their duration that stocks as measured by the S&P 500 have bottomed.
Sources: Bloomberg, NBER, Capital Economics
In all cases except for the conclusion of World War II, stock prices bottomed before the recession ended. As virus containment measures such as social distancing make their mark and drug and biotech companies advance treatments and vaccines to overcome it, we see the same outcome unfolding this time around.
Taking Action
We have articulated a view that three factors must be in place before we begin adding to equities: 1) compelling valuation 2) sufficiently negative sentiment and 3) evidence that infection rates are peaking. With stocks now trading for less than 16x estimated 2021 earnings, the first factor is increasingly in place. Heightened put-to-call ratios, bearish investment surveys (a contrarian indicator), diminishing numbers of stocks setting new 52-week lows, and lower volume selloffs are also in evidence supporting condition #2. And while infection rates have yet to peak domestically, they have in China and South Korea, leading us to believe that the social distancing and added testing that worked there will in time work here in the U.S. as well.
Accordingly, we are beginning to leg into equities to rebalance client accounts that have become overweight bonds. Our first move was to use available cash to true-up underweight allocations to small cap stocks that typically perform best out of a recession. We are now in the process of selling a slice of bonds to fund to what will become an overweight to our core large cap equity strategies. While we can’t divine when markets will bottom or whether it will be “v-shaped” or “w-shaped”, we have conviction that owning equity-weighted portfolios from this point will prove rewarding to investors with 12-18 month time horizons. As the final chart below shows, the S&P 500 performance following its worst 10 quarters since 1950 shows that stock prices in all cases have begun generating positive returns two quarters later. In the present case, we believe that past will become prologue.
Source: Strategas
Our Takeaways from the Week
Stock volatility remains elevated as investors closed the book on the S&P 500’s fifth worst quarterly performance since 1950
We are beginning to add stock exposure to client accounts, rebalancing portfolios that have become overweight bonds