The ‘big three’ stock indices are Dow Jones Industrials, NASDAQ and S&P500. Today, only down about 13% from their February 2020 high. However, the underlying Price/Earnings ratios have increased about 20% in the past few weeks even though stock prices are down overall. Major USA stock indices are more expensive relative to earnings now than even at their all time high in February!
Why? A lot of major USA companies pulled their annual earnings projections in March – which leaves analysts flying blind and just projecting based on last available information. Now the 1st quarter numbers are starting to come in and looking bleak – so the denominator in P/E ratios gets smaller – PE goes higher. Some companies are only reporting quarterly results, and forgoing projections. Analysts are still flying blind in the clouds and mountainous terrain. Stock prices are showing as more expensive as the current earning season unfolds. The next quarter earning season will be worse – fully reflecting the April lockdowns and mandatory business closures. If prices don’t drop, stocks will become even more expensive.
Why has the ‘efficient market’ not adjusted yet? A lot of buying is still on autopilot. The white collar crowd buying stock in the 401k plans are mostly ‘staying the course’. Companies offering 401k's usually limit investment choices - so a lot of those automatic savings go to big index funds. These savers are not the hourly workers that are unemployed and going to the food bank. Good advice for the young to keep dollar cost averaging – this event will be a buying opportunity. They also have company match to their own stock. This job benefit is now starting to crack. White collar workers are getting furloughed, taking voluntary time off, getting salary cuts and companies are stopping the 401k match. Less automatic stock purchases coming from this area starting in April. Corporate stock buybacks, another automatic feature, now grinding to a halt in some industries. Where cash was previously plowed back into company stock to reward shareholders, employees and executives – corporations are trying to conserve cash to weather out the storm. Some are even suspending dividends. Take a conditional govvie loan? – fuggetabout stock buybacks! Less buyers of stock means supply exceeds demand and starts to drop price. Slowly yanking autopilot buying is going to unwind over the upcoming weeks. And of course, the trader monkeys with suits make their commission on trades of stock – not with investors sitting on their hands – party on dudes!
Stock Market Ballast. Lifecycle funds and Pensions have plans that are managed within a balance of certain percentage of equity and bonds. When equity goes down, bonds in these funds and pensions are sold to periodically rebalance to their target bands. Bonds are turned into stocks. A nice steadying effect that should continue.
Buy on the Dippers. A proven strategy over the bull market run, and even during the recent bear selloff. However, this steadying effect on price only lasts as long as the dippers have capital to tap into. At some point, they run out of money to buy stocks and their support to the market goes away.
The Treasury and Federal Reserve. They get to pick and support some of the winners to save jobs in the long run with liquidity and credit and some outright grants. Some corporations will not go all the way in bed with the Fed and Treasury because it means giving up control, loan paybacks, and stock options. Not pure capitalism – but it saves the capitalist market by swerving dangerously to the socialist market. Keeps the BIG companies like Ford, Boeing and others from cratering. I sometimes like hearing ‘moral hazard’ from Washington to keep the corporate barbarians in the C suites on their toes.
Bankruptcies. Starting to show up with large department store chains and smaller energy producers. Small businesses are stressed to the max with failure of the PPP and had thin margins to being with. Airlines and Cruise ship operators are swimming in a sea of red ink. Before corporations wipe out shareholders in a bankruptcy filing, they do everything possible to soak up the last bit of credit – then negotiate for better loan terms. The bankruptcy process is not transparent to the markets and take months to pulse through the system – finally landing on the balance sheets of financial institutions. (Cue music for the Fed to enter and save the banks again.)
The supporting effect of automatic buying, the ballast, the dippers, Treasury and Fed focus on the companies with stock in the big three USA indexes. The publicly traded foreign, mid size and small size stocks don’t get as much of these supporting functions outlined above. These are down roughly 20%, 25%, and 30% respectively – compared to the 13% down for the big boys.
So – if you believe this virus impact will be over in a few months and a V shaped recovery is around the corner, or if you believe you can pick individual stocks that will rebound from those companies that are the walking dead on the verge of bankruptcy – then load up on equities.
Me? I have some utility stock with the belief that people will continue to pay to keep the lights on, intermediate Treasuries bought in January because if uncle sam goes bust its time for beans and bullets, and cash to last DW and myself into next year. Where and when is the bottom of the market – don’t have a clue except that it is in the future.
But what the hell do I know.
