Pointing to several current issues that by themselves would normally weigh on stocks significantly, Goldman sees us giving back 18% of recent stock market gains over the next 3 months.
The moment stocks started to rebound from the 35% nosedive caused by the coronavirus outbreak and its economic response, pundits started to line up to cast doubt on its staying power. For quite a while, it was even believed by many to be just a pause in a bigger move down, although we seemed to have put so much distance between the bottom now that that view has really died off.
An even bigger chorus mulled over how it should be possible for such a rally to occur in the midst of so much, while this war is still raging, without our even knowing just how much economic damage may be caused.
It turns out that people can still like to buy stocks even during these times, and that in itself serves to explain things. Only those who understand stock prices as if they were some sort of mechanistic thing have been confused by this, even though this group includes so many.
Just as fear can stretch the tether that these people think is attached so tightly to fundamentals, the sort of thing that these investors love to pounce on when it does get stretched as much as it did recently, optimism can do the same thing on the positive side, as is happening now.
Perhaps it is easier to pretend to understand stock prices that way that they do if you have no better ideas, where we are down to their being determined by certain factors to a large degree at least, as opposed to being caused by what for them appears as the unknown. When the unknown speaks this loudly, they discover how out of alignment their world is, although their response is to accuse the real world as being out of alignment. This is preferable to them than the alternative, admitting that their understanding is lacking.
We don’t want to make the mistake that they do in assuming that optimism in itself is a flaw in the pricing of stocks, something that is not sustainable and in need of correction, as an expression of the amount of deviation from their system of measuring what they believe is the true value of stocks.
This does not mean that optimism does not produce conditions of unsustainable price growth in the short run, but as we see fundamental analysts continue to need to raise their bars in the face of rising market valuation over time to keep up with reality, this demonstrates clearly that this is a force that is definitely sustained over time.
There are certainly a number of things that normally concern investors quite a bit, and the sum of these might even be of an unprecedented weight. How could we rally so much in a month and a half with all this going on? We can, just by choosing to actually, but whether or not we continue to or even change our mind over the next little while is a big question.
This rally is far from completely frivolous, as a great deal of this has been from the upward pressure that the lower prices that we dropped to just became too tempting to longer-term investors. When we spotted this start to really happen, the game was on, and it wasn’t a coincidence that this marked the bottom, and the force that propelled it had a lot of power behind it, a likelihood we easily saw and shared with you at the time.
You can’t speak of this rally without giving the value buyers their due, buyers that weren’t really concerned about what happens in 2020 other than their having the opportunity to buy these stocks this cheaply. It is actually amusing that fundamentalists will measure value as low and see people acting on this to rise prices and seek this value, but don’t claim to understand or count the effect of this upon the market.
The gap between what’s going on and their understanding of what should go on, as always, is a temporal one. Stocks drop too much, even in their eyes, in the presence of near-term fundamentals, but this creates an even bigger divide between present and future fundamentals. By long-term value investors filling this gap, by looking beyond the near-term situation and buying at the discount versus the future, this does serve to have the appearance of overbuying if we were just looking at this near term. If you are limited to this, and don’t know what’s going on, you will become confused.
We also need to recognize though that there is a limited supply involved here from the value players, as the intention is to actually get at least a discount over where these stocks started the year, and paying as much or more certainly doesn’t make sense.
As we move closer and closer to the levels that we left behind so dramatically not so long ago, this force, the driving one behind the rally, will wane. We’re seeing this happen already with the market being knocked down by relatively minor things now as they usually do without this buying force to counter it. With the nerves of the market more soothed but still fairly rattled, all those negative forces will continue to be less opposed in this changing scenario, and if the down side catches some momentum, we may indeed be in for a little tumble at least, if not the 18% that Goldman Sachs foresees.
Goldman’s prediction is said to apply to the next 3 months, taking us to August, and not even considering other potential issues such as fallout from the election or how the world may fare if a second major wave of the outbreak hits later in the year as some believe.
Looking At What is Behind Goldman’s Bearish Near-Term Call
We should look at what Goldman tells us is behind this belief, to get an idea of how reliable this prediction might be based upon their analysis at least. Their lead issue is their fearing that lessening the shutdown that we are under will cause a reversal of the downward trend in cases overall and see them increase again.
Chief U.S. Equity Strategist David Kostin believes that “while New York has thankfully been able to flatten the curve and the rate of growth of new cases has decelerated, new infections in the rest of the U.S. are increasing. Cases of infection may accelerate as states begin to relax shelter-in-place rules.”
It is not the case though that these cases are increasing. Kostin provides a graph of this and uses a 7-day average, and his average is not rising but has stabilized. This has been the case even though the amount of daily testing has really increased lately.
When we see the number of cases flatten out and decline, this is even more representative of progress than may meet the eye, in an environment of accelerated testing. If the rate of infection did not change, the new number of cases would increase proportionately to the amount of increased testing.
It’s not that just looking at the number of cases is all that informative anyway, but in order to make the number meaningful in measuring increases or decreases in spread, we need to look at the rate of infection.
For instance, the U.S. had a 19% infection rate a few weeks ago, and held close to that for a while, but has recently dropped to 14%. While that is still very high, if the goal is to measure how much worse or better that this outbreak is becoming, we need to account for variations in the number tested as well.
This is especially important to realize when you are presented with evidence like a state having 50% more infections per day after they started opening up their economy more, which might sound like things have gotten worse until you learn that they tested 80% more people than before. The incidence of infection has actually declined.
The reason why this is important to understand is that if Goldman has put substantial weight on this, there is at least a good chance that this will cause their numbers to be off by a fair bit. We might be able to keep the numbers up as we have lately by simply testing a lot more people, but even that may not be possible for long, given that even the 7-day average of new infections in these other states has peaked 18 days ago and has declined a little since, visible clearly on Kostin’s own chart, so it’s hard to see where he sees this increasing. It could, but this would require a reversal of the trend and isn’t a product of it currently.
The best we can do with these things is to speculate on them, and can at best be reasonably confident in them, perhaps enough to let this influence our investment decisions. It’s too early to say too much on how things will play out in these other states, whether this is the peak and things will slowly decline or whether the infection rate will pick up enough to significantly concern the stock market, but if we had to pick one, based upon the current numbers, we wouldn’t be betting on this becoming bad enough to scare the market notably.
Kostin believes that the market has been overly optimistic about this virus, and perhaps they have, but for a different reason. While the market may be encouraged by the economy starting to open again, the pain that the lockdown has caused is incremental, and will resume in significant increments for some time until we really are back to normal with no restrictions.
While fundamentals don’t determine stock prices, they still influence them, and by opening up half our economy, the glass is not half full, it is half empty, because it used to be full. The rest gets spilled upon our laps, and each day we are at less than full capacity, that much spills. This adds up to a really big spill over time.
While even partial economic progress is still progress, the concern from the fundamental side is how much money was not made by companies, and when we look at the market as Kostin is doing, we are speaking of the aggregate, where some companies may return to normal and some may not, and the market represents an average of all this of sorts, where all restriction weighs in to some degree.
If that’s the way stocks work, we could have just jumped on this gravy train at the start of the crash and rode it down until things returned to normal. More and more earnings are lost, and if earnings drove prices by themselves, the stocks would continue to lose as well.
In Our Tug of War, the Bears Likely Will Have the Upper Hand for a While
We could think of this a tug of war between the bulls and the bears, where investor positivism and other forces that have pushed stock prices higher versus things like companies struggling on one side, and the bearish influences on the other. As the lockdown goes on to a meaningful degree, even if at lesser levels, the bear side gets a little stronger from the further amount of uncaptured income that accrues.
When you team this up with the effect of the value players eating their fill, where the majority of those who are looking to shop at this sale fill their carts and check out, this can turn the stake with our economy getting driven a little further deeper into the ground each day and serves to empower bearish forces to pull the bulls closer to the middle in our tug of war.
Kostin does believe that it won’t just be our overly optimistic view of the shutdown lessening that will cause this retracement, it will be this together with the sum of other forces known to be unfriendly to stocks that will produce the drop that he predicts.
His bringing up the bank loan losses is part of our seeing the economic deterioration that is still to come that we are speaking of. These bank losses are unrealized yet, and will certainly weigh in later. This in itself isn’t as bad as it appears, in the face of all the stimulus we’ve thrown at this, but still something that may upset the mood of investors at least, as all of these things may.
That is where the rubber meets the road with these issues, and any issue that affects the market, and there are reasons to believe that the mood may change for the worst in the coming months.
Without the effect of buybacks, we might not have even had a positive year for stocks in 2020, as this was not a year that investors themselves were all that enthusiastic about. Ironically, they seem to be making up for it over the last 6 weeks, and brokers are reporting that retail investing has really taken off since the bounce.
That was then, and we’ll have to see how this market continues to do without the helping hand of the huge buybacks that had been accelerating. As we move more toward where we were, as the room between here and there shrinks, this additional excitement from the crash among the public will be reduced in turn, just like the push from the value buyers.
This should serve to limit the further growth of the market, as at some point people will more seriously ask how we could be in a similar place before all this mess. That part, while not certain, is at least reasonable, but how far we may decline from today’s levels isn’t so easy to call.
We’re also dealing with increasing fears of the U.S./China deal being put in jeopardy from tensions over China’s handling of the coronavirus, and Fed Chairman Jay Powell piled on Thursday by way of his seeing the economy take quite a while to recover from here. These two factors have sent us well on our way to a pullback by shaving 4% off of the rally just in the past 2 days.
Goldman’s prediction may still be a little bloated though, although quantifying such a thing with any real accuracy is pretty daunting. A lot of this depends on how much momentum the bears can build, which will be nothing like it was during the first crash, and probably not even near half as bad, the amount that is required to make Goldman’s belief come true.
This is probably not a good time to get too excited about a lot more right now though, which may in itself be enough. If you didn’t sell the first time around, or if you bought for the long term, you probably won’t be too bothered by what happens in the next 3 months, and this means that the bears may simply not get the participation for an almost bear sized move like Goldman is expecting.
2020 will probably not go down as all that great of a year for stocks in general, but when we consider what has happened already, being thrown into an economic crisis of epic proportions, it might be too much to expect anything else. This market sure can withstand a lot though, and whatever happens, investors have that to be thankful for, as things could be far worse.