Since bottoming in late March, the market has entered a rally phase and has risen by more than 20%. In fact, it has retraced nearly half its 35% loss since its mid-February peak and remains down about 15% year-to-date. Fortunately, many individual investors have performed better than the broad market average thanks to diversified portfolios that also own bonds and commodities, such as gold.
Including last week’s five million new jobless claims, the tally of 22 million freshly unemployed workers over the last four weeks (and likely more to come) means that all the jobs created since the Great Financial Crisis have been wiped out. For most individuals, financial markets appear truly baffling – and many wonder how the last two weeks turned in their best two-week performance (+15% through last week) since the 1930s in the face of soaring jobless claims.
The JNBA Investment Committee believes the market has rallied on the basis that we could be inching closer to “re-opening” the economy, as the data surrounding the worst-case COVID-19 scenario is not currently as dire as originally feared. Many investors are extrapolating that better news on the health front will mean better news on the economic front. When combined with a deeply oversold market and fresh stimulus from the Fed and Treasury, all these factors jolted markets higher after the vicious sell-off.
Yet, we’ll remind investors that major rallies during previous bear markets have often been short lived, as illustrated in the charts below shared by Oaktree. We are just beginning to see the economic damage inflicted by the lockdowns as companies begin to report Q1 results (remember that Q1 results will include two months of pre-COVID-19 data so the full effects will not be completely reflected). Currently, FactSet research estimates 2020 earnings per share (EPS) down 14.4% while analysts are modeling earnings to climb to a new highwater mark in 2021, which we think would be very challenging to achieve. After the last recession, earnings did not surpass the highwater mark of 2007 until 2011. While banks are healthier and this is not a systemic crisis relating to the underlying plumbing of our financial system, unemployment is much higher this time around and companies are carrying nearly twice the level of debt than they were back then. Although the fiscal stimulus this time around is quite large as a percentage of GDP (around 10%), which is a good start, it is difficult for the stimulus to have as much of an impact when so many businesses are shut down.
As a reminder, a recession occurs when the mix of goods and services provided by businesses do not match what is demanded by society. Until that imbalance is corrected, the recession persists. On this basis, it appears as though this could be a longer-lasting recession than what is currently being priced into financial markets. In addition to a significant decrease in company share buybacks, there are many stores and commercial real estate projects that were financed by cheap debt and may need to be restructured in the years ahead, while needing to take into account consumer and business behavior shifts coming out of this downturn.
Currently, we remain underweight our base equity targets in JNBA portfolios and note that market bottoms are often a process as shared in our April 16 podcast. It would not surprise us to see a pullback after such a sharp rally. We believe there are plenty of potential catalysts, including future corporate bankruptcies (e.g., energy, hotels, travel, retail, restaurants); slower than expected re-opening of economies; EPS revisions to the downside given lack of earnings visibility; resurgence in COVID-19 cases as we ease lockdowns; and others. In our opinion, the all-clear likely will be when we see a medical breakthrough such as a vaccine or effective treatment regimen for COVID-19. We also would expect improved financial conditions reflected in tighter credit spreads within fixed income as well as for small cap and/or value stocks to take the commanding lead from today’s “leadership” in the market – currently large companies and growth stocks.
Please know that the JNBA Investment Committee is monitoring and managing through this for you, working diligently on your behalf, and keeping your goals and best interests front and center as new information becomes available. We will continue to share relevant market-related information that guides our portfolio management practices.
Thank you for your continued trust in JNBA not just as your financial advisor, but also as your advocate. Please do not hesitate to reach out to your advisory team if you need anything at all.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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