Market Strategy 5/11/2020

Key Takeaways

• Investors last week had a reminder that stocks are a forward–looking discounting mechanism as equities advanced after an historically poor jobs report on Friday.
• Improved news flow tied to drugs under development to counter the Covid-19 virus as well as a flattening of the curve at the epicenter of the US outbreak boosted market sentiment to push stocks higher.
• Politics continues to contribute to tension in the market as politicians from both sides of the aisle take opportunity to snipe at one another over the management of the Covid-19 crisis.
• We update our earnings score card for the 87% of companies that have thus far reported. The season thus far has revealed both winners and losers in a tough environment.

As we prepared to go to press with this week’s publication equity markets were rallying in Asia. The gains appeared to be an extension of the rally that took equities higher stateside and in the developed international markets through last Friday’s close.

Even as economic data provided enough headline risk to make stocks stumble last week—they didn’t.

This week could find investors caught between FOMO (fear of missing out) as well as fear of staying too long “at the party” should stocks persist moving broadly higher.

The S&P 500 has rallied over 30% from the bottom reached on March 23. All 11 sectors of the venerable benchmark are higher in the period with gains ranging from as much as 62.82% in energy to 18.9% in consumer staples.

The forward P/E multiple of the S&P 500 has expanded from a closing low of 14.02 on March 23 to reach 23.07 on Friday, May 8.

Forward valuations certainly appear somewhat stretched based on Q1 earnings season thus far and what’s expected for Q2 by consensus analysis.

The economy is currently experiencing a contraction the likes of which none if any of the generations working in the markets today have experienced in their lifetimes. And yet stocks have been able to move higher.

The jobs report released last week came in slightly under the dire pre-release forecasts but ghastly enough to gain even the most hardened optimist’s attention with the US non-farm payrolls shrinking by 20.5 million jobs in April.

Barron’s (the financial weekly publication of Dow Jones, Inc.) in commenting this weekend about the employment numbers released last week noted that the number of Americans who lost their jobs in April were twice as many as those who had lost their jobs in a two year period of the Great Recession of 2007-2009. However, the silver lining in the latest downturn was that 80% of the jobs lost were listed as “furloughed” implying the potential of a back-to-work call when the economy begins to regain traction.

Instead of losing ground stocks moved higher on Friday after the release of the jobs data to post gains for the week with cyclicals outperforming defensive sectors among the large caps of the S&P 500 while the NASDAQ Composite (about 40% weighted in tech and tech related names) moved not only higher on the week but turned positive on a year-to-date basis.

Q1 earnings season with 87% of companies having reported thus far shows earnings off 7.24% from a year ago on the back of anemic revenue growth of 0.9%.

The financials, consumer discretionary, industrials, materials, energy, and communication services sectors have shown negative earnings growth in the period while health care, utilities, information technology, consumer staples and real estate delivered positive earnings growth.

In our view at the core of a very mixed bag of economic data and corporate results stands the Covid -19 crisis and the economic shutdown that is designed to stem the virus’ spread and prevent greater damage to society and the economy than might be sustained if the virus were left to run its course freely.

A presidential election year concurrent with all that’s come to pass adds a level of politics when addressing the serious health and economic issues on any given day as politicians from both sides of the aisle seize the opportunity to snipe at each other.

As with most crises we have experienced in more than three and a half decades in the markets work-out periods are uneven in delivering their results. The darkest hour is always before the dawn and things eventually do get better if not as soon as optimists would like but usually just in time to cause great consternation and sometimes denial among the proverbial doomsayers.

In our view the market last week found wind beneath its wings to move higher from:

• Progress at the epicenters of the pandemic (in terms of new cases reported, death count momentum slowing);
• A flattening of the curve;
• News of drugs on the horizon that could deal with greater efficacy in treating the afflicted;
• News of the potential for immunization drugs to be approved sooner than originally expected;
• Q1 results that underscore the fact that earnings season has produced not just losers but a good number of winners;
• A majority of states moving toward reopening their economies;
• A number of countries around the world moving towards reopening.

Of course there are setbacks. There never is an all clear signal sounded over life, over the markets, or over novel and deadly viruses.

We suggest investors be prepared for any catalyst that might emerge near term to provide opportunity for nervous investors and short-term traders to take profits without FOMO (fear of missing out).

Such catalyst notwithstanding we persist with our view that the interim rallies that have become an extended rally for stocks illustrate which direction the market wants to take as the terrible chapter in market history titled The Covid-19 Pandemic is worked through to some kind of resolution.

We recommend that investors focus on diversification in equities with a preference for cyclical sectors including technology, consumer discretionary, industrials and financials over defensives such as utilities, consumer staples and real estate. Health care remains a special situation as advanced pharmacology, biotechnology, diagnostics and equipment remain central to getting out of the mess the world is in.