The Stock Market Continues to Rally

The worst is yet to come…

In my last article I wrote on how I thought the market had not been through its worst for its part in the Coronavirus pandemic. I am a long term Bull, but as of right now, I can see why Bears are gloating and stirred up. The worst is yet to come, even though the majority of investors think that we are already in a Bull market for the long run. How is it possible that the S&P 500 levels are trading at around 2850 points after such a horrible dip of 34% that occurred just less than a month ago? Roughly about a month ago the S&P 500 levels were trading at 2200. It’s just mad to think that the S&P 500 level keeps holding up at 2850 which is very close to its 3,300 all time high, it’s only down 15%. The stock market has disconnected itself from the economic reality we are experiencing. Just a week ago, the oil futures plunged below zero to all time lows. We are standing on thin ice and it’s all thanks to the FED.

Unemployment rates are through the roof, we are seeing worse unemployment rates than the ones lived in the Great Depression. The US economy has just wiped out all of the jobs it created since November 2009, after the Housing Market Crash. The jobs that were created throughout roughly 10 years, were all erased in less than 5 weeks.

This will just get worse, today Uber’s CTO resigned after the company reportedly considered cutting 20% of its workforce. People have been rather optimistic this week because of some “good” earnings reports on some companies this week. Although many small companies like Diamond Offshore Drilling are filing for bankruptcy. Even though many companies reported big declines on profits, they were above investors’ expectations. Take Adidas for example, the stock had dropped 45% already. When the earnings report was released, their net income decreased 97%, but it still was able to turn a profit of $20 million euros, which is greater than what investors expected.

What people don’t understand is that the earnings reports that we are seeing, are puffed up with Pre COVID-19 earnings. The true negative effects of the COVID-19 will be seen in the next earnings reports in Q2, then it will be a bloodbath. Even Ford Motor Company is bracing for the impact. Ford just missed this quarter’s EPS estimates, and already announced their results for the second quarter are about to get far worse thanks to COVID-19. Luckily, its CEO announced that they have $35 billion in cash, enough to survive the whole year without any production. On the other hand, companies can learn a thing or two from JP Morgan. After missing its Q1 EPS estimates, its stock took a hit. Its profit plunged by 70% but because they relocated those profits to their reserves. What investors didn’t realize is that they increased their credit reserves by $6.8 billion in anticipation that people might not pay their credit card bills. If you were to add the $6.8 billion to their earnings, they actually did beat the EPS estimates, but they are bracing for the future. The EPS estimates for Q1 were $1.7, but JP Morgan reported $0.78 EPS. If we divide the $6.8 billion by the number of outstanding shares (roughly 3 billion shares), it gives us a total of $2.23 per share. If we add that to the $0.78 EPS they reported, we are talking about a $3.02 EPS. Far greater than 2019’s Q2 EPS of 2.5, an increase of 20% roughly.

Although the narrative that the economy will have a V-shaped recovery can’t be proven false until it does not happen, I think it’s a fantasy investors are dreaming of. With a partial reopening of the economy starting, we will be able to see at least some level of stifled demand coming back in the economy, fueling a V-shaped recovery narrative. In Q3 earnings is when we might see a V-shaped recovery after the huge losses, even though it’s a long shot in my opinion. Whether we see a V-shaped recovery or not, depends on how the US government manages the reopening of the economy and the COVID-19 containment. Germany decided to gradually reopen certain parts of its country after achieving one of the lowest fatality rates from the virus in the world. Sadly, it is already seeing repercussions with infection rates ticking higher. This can offer insight to US governors and politicians, given that they are considering early reopening. Some states are planning to reopen movie theatres, restaurants, gyms, hair salons, as soon as this week. If the US isn’t careful about containing the virus, it could get hit by a second wave of infections and its economy will not see a V-shaped recovery.

So the stock market continues to rally because of the FED’s support. My challenge with this is that some companies that actually need to go bankrupt (businesswise), will not and just inflate their debt until its bubble bursts after a shock. The FED is pumping trillions of dollars into the economy with hopes to stabilize the FI markets. The stock market is forward looking, but it is currently biased to the EPS estimates that are continuing to fall, which in turn are increasing valuation multiples that are already high. The S&P 500’s PE ratio is up at 20.9x currently, an increase compared to the beginning of the year which was 18.2x. The current PE ratio is even above its ten year average of 15.0x. Many big companies such as IBM, Coca-Cola, Intel, FedEx, AT&T, have suspended their earnings forecast guidance for this year due to the uncertainty the coronavirus pandemic has caused. Some companies have even suspended dividend payouts. Still, investors are giving companies a pass on low earnings. More than a third of the companies that have already reported earnings, missed Q1 earnings estimates and have seen small declines in the earnings reaction day, compared to historical averages.

References

Related posts:

Aristotle once wrote “happiness depends upon ourselves.” In this world happiness isn’t easy to come by. We must create our own happiness or we will suffer for the rest of our lives. Happiness is…

Who would have thought of the change in the mobility landscape we might be about to encounter. Although the Electric Vehicle (EV) maker Tesla has grabbed this emerging market by the horns, new…

We tell children when they’re young “there is nobody else in the world exactly like you.” We are all unique and have the capacity to impact the world and the people around us in amazing ways. The…