By David Nelson, CFA
At 7:50PM April 13th, 1970 Fight Director Gene Kranz was sitting at his desk in NASA’s Mission Control facility. Five minutes later he was about to receive a radio transmission from the crew of Apollo 13 that would change his life and that of everyone associated with America’s Space program. With the words “Houston we’ve got a Problem” still echoing from a spacecraft hurtling 200,000 miles from earth he gathered his team to weigh their options on how to bring the astronauts safely home. Coming out of that meeting the message from Gene was clear; failure is not an option.
Today America faces a similar crisis fighting its worst pandemic in a century with its physical and economic health and yes, the fate of the nation hanging in the balance. Our response and message to the world should be the same as NASA’s fifty years ago.
While stock market performance pales in comparison, throughout history it has acted as a report card measuring both success and failure. It has crashed during wars and depression and soared during times of peace and prosperity. Falling from an all-time high on February 19th to a desperate low March 23rd stocks reacted violently to rising fear and uncertainty. Perhaps better than traditional polling, investors voice their opinions with real money.
S&P 500 – 522 Trading Days
Current price levels for the S&P 500 should be familiar territory. Stocks have been trading in a narrow range for well over a month. Living between 2955 as its ceiling and a floor of 2728 a 7% range may not seem narrow but in the context of a (-44%) decline followed by a 31% jump off the March 23rd low, the term takes on added clarity.
We can go back much further in fact a full two years to better define the trading ban. More than 1/2 of the last 522 trading days stocks have traded between the same ceiling and floor. Stocks fell from support in the 4th quarter of 2018 fearing an aggressive Fed and the potential of higher rates forcing institutional investors to de-risk, perfectly happy to clip coupons while loading up on fixed income. By March of 2019 following a stunning reversal in Fed rhetoric and policy, stocks jumped back into the range finally breaking to new highs later in the year.
The point is stocks have memory associated with prices at these levels and it makes an excellent barometer to judge just how much confidence investors have in the current market and or economy.
The Economy has Bottomed
While we are about to experience a record low GDP print for the second quarter, perhaps (-30%) the economy has clearly bottomed. We’ve had little economic activity in the last couple of months so any increase will be an improvement. This does not mean we are out of the woods and don’t face massive challenges in the weeks and months ahead. The damage is severe and for some industries i.e. close proximity businesses like retail and airlines it could be more than a year before we can reach what we previously would have thought of as recessionary.
As states start the process of turning on the lights and in turn their economy investors can expect a bumpy ride as we navigate success or failure. Already we are looking well past 2020 earnings hoping normalization can occur next year where current consensus for S&P earnings sits at $163 implying 28% growth over this year’s depressed levels.
In that context the current trading range will act as report card on just how well we are doing. When stocks start living above the range it will be a strong indication of a passing grade. Below the line implies more work to be done.
Current consensus for 2020 S&P earnings sits at $127. Goldman’s $110 estimate is likely closer to reality a level we haven’t seen since 2013. In a vacuum at 26x this year’s earnings valuations are rich but given this was a downturn caused by an exogenous event rather than an economic imbalance investors have chosen to look beyond current conditions expecting a recovery in Q3 and Q4 continuing into 2021.
As we dig deeper, we can see the economic damage from COVID-19 has been uneven and confirms the Two Markets theory I put forth in this column a few weeks ago. The Goldman table below reinforces the argument; Designated Survivors vs Everything Else.
To Goldman’s point on the top half of the table Utilities, Info Tech and Consumer Staples top the list of winners with Consumer Discretionary, Financials, Energy and Industrials seeing a dramatic fall in growth, sales and just about every line item of the income statement.
While a vaccine is clearly the best chance of a return to normalcy even in its absence there are success stories. Big cap tech with fortress like balance sheets along with stay at home stocks have been relative winners. Amazon (AMZN), Netflix (NFLX) and Activision (ATVI) are just a few examples.
Even within some of the most challenged industries like retail some have innovated succeeding where others have failed. Best Buy (BBY) revamped its business model and was able to maintain well over 2/3 of previous sales using curbside pickup to replace lost customer traffic from store closings. Other retailers turned to online growing their digital presence dramatically. Target (TGT) was able to increase digital sales 275%.
Healthcare is another stand out. With half the pharma companies on the planet working on a vaccine or therapeutic treatment perception of the industry has morphed from part of the problem to our single best hope at combating the pandemic.
Short of a vaccine and or cure for the coronavirus just how fast states can re-open without triggering a surge in viral outbreak is key to market performance and of course success.
FAILURE IS NOT AN OPTION!
*At the time of this post some funds managed by David Nelson we’re long AMZN, NFLX and ATVI
