Does an Above-Average Priced Market Based Upon PRE-PANDEMIC Earnings Expectations Make Sense?

Apr 17, 2020 | Nick Scholte


Only if you believe A) the economic rebound will be V-Shaped, or B) you shouldn't fight the Fed. Well, I don't believe in A. B is near impossible to quantify, but admittedly is an open question.

To my clients:

First, a comment. We (RBC Dominion Securities in general; Brenda and I in particular) are fully open for business and fully functional. We work in an industry that translates quite well to “work at home” initiatives. Yes, there are some work arounds required for documentation and similar requirements such as cheque issuance, but the disruption has been minimal. I raise this matter simply because a couple of clients in recent phone conversations with myself expressed surprise at reaching me (on my regular work telephone number) as well as my ability to access data and information. Let me be clear – you can reach me just as you always have on my regular work phone number. Further, my home work station is identical in every way – except one - to that at the office. The lone difference is that I have one physical screen to look at instead of my multiple screen setup at the office. All this means is that I have to do a bit more clicking back and forth between applications (I’m getting pretty good at it now!). REGARDING THE MATTER OF CHEQUE ISSUANCE – IF YOU ARE NOT SET UP FOR DIRECT BANK DEPOSITS, OR ELECTRONIC ACCESS TO STATEMENTS AND TAX DOCUMENTS, PLEASE CONTACT BRENDA TO DO SO. IN THE CURRENT ENVIRONMENT, IT JUST MAKES SENSE TO BE SET UP FOR THESE SERVICES.

It was an up week for North American stock markets with the Canadian TSX finishing up 1.4%; the U.S. Dow Jones Index finishing up 2.2%; and the U.S. S&P 500 finishing up 3.0%.

I titled the website version of my February 7, 2020 weekly update Woulda, Coulda, Shoulda... But Comfortable I Didn't The capsule comments accompanying the title that week further stated: “As expected, Manufacturing has indeed rebounded and confirmed strengthening economic readings elsewhere. But coronavirus concerns keep me from adding back equity. This may change early next week.” This update was written during the early stages of the coronavirus crisis, before it truly emerged into widespread consciousness as a worldwide health and economic threat. At the February 7th juncture, North American economic data was still healthy and improving, and I had been actively considering adding additional equity to client portfolios. I had specifically said (through much of January) that if Manufacturing data reported on Monday of the first week of February showed improvement, that would be the trigger event for the additional equity exposure. In fact, the Manufacturing data did improve, but I DID NOT add back equity as I had previously suggested I would because of the coronavirus concerns. Owing to my own research at the time looking at the potential ramifications of pandemic spread of the virus it led me to state that I was comfortable that didn’t follow through on the previous pledge – despite the fact that markets finished strongly higher on the week owing to the good manufacturing data. In retrospect, I’m obviously glad that I didn’t follow through on my intent, and even happier I was quick to substantially reduce equity in the subsequent weeks and go very underweight equities in client portfolios.

I make the point in the previous paragraph because I find myself in a similar situation now, but my response is different. This time I am uncomfortable. Rationally, just as in early February, I believe caution and prudence remain the best course of action for portfolios at the present time, but the very substantial stock market rebound (slightly more than half the losses from the February peak have been recovered) make it challenging to stay committed to this viewpoint. Especially in light of the massive fiscal and monetary stimulus proffered by governments and central banks respectively. But I feel I must stay committed. At least until circumstances change in a material way.

If I could offer one stat to justify my position, it is this… the CURRENT price/earnings multiple (i.e. the amount of dollars an investor is willing to pay to own stock to generate $1 of annual earnings) is 17.5X. In other words, investors are presently willing to pay $17.50 for $1 in earnings. This compares to the 5-year average of 16.7X. Oh, and by the way, I left out one crucial bit of information. This 17.5X multiple is based on PRE-PANDEMIC estimated earnings!!! So, in the here and now, investors are willing to pay an above average price-earnings multiple based upon earnings estimates from BEFORE this crisis started, and that are not remotely achievable any time soon. Does that make sense to anybody? I’m sure the counterargument would be some combination of the following: A) the dip in earnings will be brief and this will be a V-Shaped recovery; and B) don’t fight the Fed - the Fed stimulus will take care of all concerns. To “A” I say I am highly, highly, highly (you could add as many more “highly’s” as you wish) skeptical. More to the point, I flat out don’t believe it. Despite yestedrday's announcement in the U.S., re-opening the economy safely will be slow and bumpy, possibly beset by periodic reversals, and normal consumer behaviour will also be slow to return.  To “B” I say, yes, this is possible. For sure it is a wild card that is difficult to quantify or dismiss.

Clients know I rarely leverage the written comments of RBC in these weekly updates. I really prefer that clients know that these weekly comments are direct from Nick Scholte and represent unvarnished insights into the thoughts and actions that I am personally taking on behalf of clients. That said, there are occasional exceptions. Today is such an exception. Weekly commentary published yesterday by RBC Wealth Management offer thoughts on the recent stock market rally. I’ll end my update this week with their thoughts:


While the catalysts that drive bear market rallies differ dramatically from one bear market to the next, it’s interesting that the magnitudes of the rallies are similar. For example, during the COVID-19 crisis, the S&P 500 climbed 27.2 percent from Mar. 23 through Apr. 14, its recent high point.

During the bear market associated with the bursting of the tech bubble and 9/11 attacks, the S&P 500 rallied between 19.0 and 21.4% on three separate occasions, according to Bloomberg.

During the global financial crisis bear market, the S&P 500 staged two big rallies less than one month apart in late 2008. The first was an 18.5 percent move, followed by a separate 24.2 percent run.

Such moves provided opportunities to “reposition portfolios” (emphasis Nick’s – read: take profits by selling into strength) until the full bear market cycles were flushed out of the system. We think the lingering uncertainties argue for keeping some powder dry, and holding equities at the Underweight level in portfolios.

That’s it for this week. All the best and stay safe,


Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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