Upsized Uncertainty: The Opposite of Lower for Longer

Road to Recovery written on desert road

by Paul Broughton

Within just a mere few days in early March the U.S. went from economic expansion and record low unemployment to a severe, deep contraction and record high unemployment. The S&P 500 reflected this by falling about -34% from its high on Feb 19th to the March 23rd low. And since that low the S&P has rallied by over 36% – this sharp rebound seems to then reflect an optimism that the economy will have a solid recovery. What’s fueled this optimism and what should investors be thinking about as we progress into the second-half of 2020?

Since the onset of the pandemic in the U.S. in early March the economy has been boosted greatly by record amounts of fiscal and monetary stimulus. Congress and the Fed moved swiftly and aggressively and both stand poised to possibly add further economic aid to the economy, if necessary. With this as a backdrop, bullish investor sentiment seems to be betting on a potential vaccine, the successful re-opening of the economy and pent-up consumer demand fueling a quick economic recovery. So, have we rallied too much, too fast? Perhaps. Or, did we fall by too much? That’s also a possibility. Over 40 million Americans have filed for unemployment benefits. Consumer spending on restaurants, air travel, hotels and lodging, movie theaters, theme parks, etc. remains understandably absent. As well, the U.S. oil & gas industry is under significant pressure due to lower demand and a global supply glut. Additionally, live events such as concerts and sports remain on hold.

Even so, an economic recovery is now beginning. Restaurants are slowly reopening for dine-in seating, but with constraints in many states on occupancy levels. Many restaurant owners will struggle with profitability and staying open. Air passenger traffic is gradually improving – down 88% from one year ago last week. This is an improvement of the low of a 96% decline in mid-April. Sports is coming back, but MLB, the NBA, and NHL are all considering playing games without fans. This will be a significant hit to team revenues and in turn a hit to the stadium employees and suppliers. The Chicago Cubs have stated that 70% of their revenues are from game day revenues: ticket sales, parking, food & drink, merchandise, etc. Ohio State’s football team will likely be playing in front of anywhere from 20,000 to 50,000 fans depending upon plans – their stadium (The Horseshoe) seats nearly 103,000. The University of Michigan’s president, Mark Schlissel, has said that there won’t be any sports if students aren’t on campus taking classes. There are many more negative examples of the virus’ impact on people and businesses.

Not all is negative. There are many examples of consumer behavior and spending shifting to other areas of the economy. Broadband internet providers are experiencing increasing demand for faster internet speeds. Demand for campers and recreational vehicles is up sharply as reported by dealers. As well, demand for inground pools is also up sharply year-over-year as reported by pool builders and pool supply companies– many saying that a new inground pool won’t be done until spring 2021 due to backlog. Home improvement retailers are also seeing stronger than normal sales due to consumers spending more time at home.

The point of all of this is that uncertainty remains higher than normal and likely will be for the next few quarters at least. Earnings estimates for the next twelve months are probably more uncertain than at any time in the past fifty years. Attempts to label the market as expensive, reasonably priced, or cheap, in our view, lack foundation, given the uncertainty in 2020 and 2021 earnings forecasts. The one thing that is certain at this point is that the American economy is showing signs of resiliency and gradual improvement and the markets are reflecting this – time will tell to what degree we’ve recovered, whether by too much or too little. Sometimes the best investment decision is to not do anything – to not overreact. Getting some perspective by carefully reviewing of your investments and your original investment thesis is helpful in moments like this.

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