The Bull Cases

Secretary of the Treasury Steve Mnuchin said on April 19th that it will be months, not years, before the US economy is back to its previous strength. He has a big hand in making that happen. The Federal Reserve and the government have introduced record stimulus packages in record time, and clearly they are not finished. In the face of this coordinated activity, riskier assets reversed course and stocks started rising. Bulls say the worst is over. Let’s take a look at what they have to say:

Bonds Speak First

The most difficult part of investing in the current environment is that the economic and fundamental data are overwhelmingly negative. Two of our previous articles laid out the case for raising cash. Today, the current stimulus from the Federal Reserve, Bank of England, European Central Bank and the Bank of Japan is without precedent in size and speed. 

Bond markets tend to be more sensitive than equity markets. Often, that means that bond markets will pick up bad news before equity markets. On March 9th, the high yield spread broke 600, indicating severe financial distress. Now, the spread has come down from a high of 1087, although remains elevated. The bond market is saying that the distress is significant but no longer severe, for now.

When the Fed commits to wholesale buying, it doesn’t care about price. The Fed’s goal is to send the signal to the markets, “you are safe and you can sell to me”. The Fed has effectively put a floor under the bond market at the cost of $2T. High yield is not in distress today as a result. Mnuchin and Powell can’t fix the virus but their fiscal and monetary responses have taken many of the worst-case scenarios off the table.

An update on where we are today

Every day feels like a week in this market. Here are key developments to keep in mind:

• The S&P 500 is in a technical bull market, having risen 25% since the March low.
• The fiscal and monetary response has been fast – within days and weeks of the original crisis onset. In 2008-09, fiscal and monetary stimulus took months. 
• More fiscal stimulus from the Federal government is coming in the form of loans, aid, reimbursements, and loan forgiveness.
• More monetary stimulus is coming from the Fed. The current balance sheet can go from $6 trillion to $10 trillion this year. The Fed keeps raising the limit on its purchases.
• Long term interest rates are at record lows. The ten-year Treasury is at .59% and the thirty-year Treasury is at 1.17%. The annual cost to service new debt by the US Government going forward is very low.
• After a recession concludes, US stocks can perform exceptionally well. We are clearly in a recession. Stocks advance afterward until the next recession hits.

Stocks move ahead of news. The news about growing unemployment and no earnings is awful. But stock prices are moving up based on the expectation of what will happen in the future, not what is happening today. In 2022 unemployment will have fallen dramatically from the current 18% and many earnings may be approaching their previous peaks. We know that the stock market does not perfectly correlate with the economy and in fact, the economic cycle tends to lag the market cycle.

Stocks can ignore all the bad economic news and look ahead. With promising news on the cure front (Remdesivir and others as well as the development of a vaccine in record time) then stocks may be able to continue to advance for a while as the market “discounts” future expectations. But if the news from the virus front starts to turn bad, well, we all know what will happen next. A rolling wave of shutdowns over the next 18 months seems most likely.

Government orders are working. Stay at home, social distancing, masks, and frequent cleaning are turning the tide in the US. There are a series of rolling peaks in new cases and those peaks will decline with time until there is a vaccine. For government and health leaders there is plenty of fault to spread around, as well as plenty of praise. Any student of history knows that the ‘fog of war” obscures the best approach. Only afterward is the path obvious. Many times the best path is repeatedly not chosen, but the battle is still won.

Two Opinions:

Opinion: Stock prices are being driven by medical developments. Since the likelihood of treatments, improved tests and vaccines is growing, the market is discounting the ‘return to better’. Better may mean substantially better in the form of faster responses to future viruses and robust healthcare systems designed to respond broadly.

Opinion: Most people become quite negative on their personal situation during a widespread crisis. It happened after 9/11. Who wouldn’t become negative after working at home for months, laying off employees, unable to travel, and applying for SBA loans? When negativity spills over into investments, investors reason that if their personal lives are upended then their portfolios are, too. The initial negative shock of the pandemic was so large that current and future negative news doesn’t impact investors as much. The worst of the psychological impact of these events may be behind us.

Skeptics everywhere

Howard Marks of Oaktree, Scott Minerd of Guggenheim and Jeff Gundlach of DoubleLine are the leading bears at this moment. Hundreds of billions are invested with them. They are successful long term investors so I wouldn’t completely dismiss them. 

On balance I suggest continuing to take a defensive stance. “What we don’t know” is the most important phrase, even more than “it’s different this time”. Charlie Munger said in an interview on Friday last week, “Of course we’re having a recession. The only question is how big it’s going to be and how long it’s going to last. I think we do know that this will pass. But how much damage, and how much recession, and how long it will last, nobody knows.”

Being right includes calling each trend in a market. Being responsible means keeping and growing capital through all market environments and eliminating the risk of ruin. It’s not possible to know what will happen next in this environment. It’s worth listening to both the bull and bear cases.