Kingsmill’s Investment Miscellanea: Friday April 3, 2020

Apr 03, 2020 | Joshua Kingsmill


Key Takeaways:

  • Two camps for what will happen “Bull Case” and “Bear Case” are opposites
  • There have been 3 recessions in the last 30 years:  the market has gone up well in advance of the actual economy improving
  • A market bottom could come when there is the confidence that the coronavirus outbreak is subsiding.

I am asked, and I invite others who spend much time trying to figure out: What’s next. I’m going to outline what I believe are views for the optimistic case and the views for the pessimistic case. Then I will go through what the last three recessions looked like in terms of market catalysts on the way up, to perhaps give some reference for what might happen this time.

In the most optimistic case: in the next six weeks to 2 months, everything opens up, and most people are back to work, the damages are understood, and the economy goes back to normal in 6 months. So that would be a Labor-Day resumption or pre-coronavirus working and living conditions (that seems so long ago, even though it was a few weeks), and we are on the other side.  In this scenario, with the multiple trillions of dollars spent around the world, incredibly low energy prices, 0% interest rates, and a huge demand for everything with cheap money and no long-term devastation to the economy: we are really into another roaring ’20s (the 2020’s).

In the most pessimistic case, unemployment in Canada and the US increase to well over 20%. It takes 12-24 months (or longer) for things to back to normal. The coronavirus has a second wave, and there is a huge demand shock, social unrest and the economy is permanently damaged. As a result, it creates another depression or worse that history has never seen.

We’ve had economies severely damaged by wars, acts of terrorism, oil shocks, dot-com and real-estate bubbles, financial crises, traditional end-of-cycle recessions. Some have said: well this time it’s different: we have never had to deal with a pandemic before. While technically correct, this is a medical and health crisis; it will have the same effects on the economy and the markets as every other crisis. We just don’t know what the magnitude of the consequences of this latest one is. But it does not change the fundamentals that occur every time there is a massive hit in earnings as a result of a recession. The cause of this downturn might be different, but it will follow the same types of things that occurred in every other downturn.

There have been three economic recessions over the past 30 years. This is different from a market correction:

  1. 1990-91 recession—brought on by war and an oil-price shock—sales for S&P 500 companies dropped 7%, and earnings dropped 30%  It took less than a year for S&P 500 sales to recover, and two years for earnings to hit new highs. The stock market, however, hit bottom around the fourth quarter of 1990: a few quarters before earnings bottomed. 
  2. During the bust in 2000, sales at S&P 500 companies dropped 10%, and earnings dropped 25%.   Again, it took a couple of years before sales and earnings hit new highs, but the stock market bottomed two quarters before the worst earnings were reported.
  3. In the 2008-09 financial crises, sales at S&P 500 companies dropped 9% peak, and earnings dropped 50%. This was the most severe drop in earnings or the three recessions. Again, it took a couple of years for sales and earnings to hit new highs. And again, the stock market bottomed two quarters before the worse numbers were reported.

If there is one takeaway that I’d like you to remember from this: it’s that stock markets historically bottom well in advance of the worst fundamental numbers.

So we don’t know yet how far earnings will fall. Ultimately, its earnings, and what companies anticipate they can earn that moves the stock market over time. Ones take on how bad it will be, depends on where they are on the optimistic/pessimist side of the ledger. But we don’t know.

Concerning those who believe we can time the market perfectly (with hindsight being the judge), I think that we all (consumers, companies and governments), need to have confidence that the outbreak globally is subsiding. I don’t know if that’s when cases peak, or when there is a vaccine, or tests are available to everyone. We don’t know when this actually occurs, but it should be well in advance of the reduction of headlines and data on how bad it is for the economy, companies and unemployment rates.

This week, I include an article I found helpful. Those who know me know that I’m optimistic by nature and belief. However, we are all dealing with the emotions and realities of this unprecedented moment in history. We can’t pretend that “it’s all good,” all the time, nor ignore what we are dealing with. This article talks about the discomforts we are all facing.