Published April 24, 2020
Below we find a good summary of the current market situation from Delta insights. They note that stocks are expensive relative to history, with earnings outlooks unusually foggy, and the market’s high concentration in only a very few companies further cause for concern. Here’s Delta’s summary with our notes at the end:
“COVID-19 has much of America caught in a loop when every day seems the same. Businesses are closed and we wait to see what happens next. Repeat.
The stock market, for the moment, has found a Groundhog Day equilibrium. With the S&P 500 at about 2,800 for the past week – down by about 600 points from the high and up by about 600 points from the low – there seems to be collective recognition that much of the service economy is at a standstill, the online-economy is fine and the future may change quickly.
As the dust settles on the first quarter, we are learning more about sources of selling pressure that caused a three-week, 35% decline in the S&P 500. Hedge fund capital fell by $366 billion during the quarter and it is likely much of it was in March. Investor outflows were $33 billion, the largest amount of outflow since 2009 and the 4th largest in industry history.
This week, the oil futures market collapsed with the May delivery futures contract for West Texas Intermediate (WTI) trading intra-day at -$40/barrel. Oil storage is near full and demand is depressed. Declining oil futures prices will do much to signal to producers to limit supply and eventually bring the market back into balance. The SPDR energy ETF (XLE) touched $22.88 on March 18. From the low, XLE is up 54%. From the year-high, XLE is still down by about 50%. Energy has likely seen the low and has significant room to appreciate before returning to previous peak levels.
Earnings reporting season began on April 14. On April 13, the S&P 500 closed at 2,761.63. Contrary to many analyst predictions, earnings season has not been a disaster for the market so far.
The S&P 500 at 2,800 is expensive relative to historic price-to-earnings (P/E) averages based on current consensus earnings forecasts of $120 in 2020 and $150 in 2021. If these earnings estimates are correct, the 2020 P/E of the S&P 500 is 23.3x and the 2021 P/E is 18.7x. The 25-year average P/E is roughly 16.5x. If these earnings estimates get cut, the market becomes even more expensive relative to its history. Of course, with interest rates at such low levels, bonds are offering little incentive to invest in bonds, other than perhaps more stability in your investment.
In an investment environment with persistently high uncertainty (CBOE Volatility Index, VIX at or above 40 for the past seven weeks), it seems odd that the S&P 500 would temporarily stabilize at a historically high P/E multiple. Elevated uncertainty is normally associated with depressed valuations. The consensus expectation is it will take at least a year to create a vaccine and the economic re-opening process will be phased over a relatively long-time.
The S&P 500 at about 2,800 indicates 1) much of the market cap of the index is fundamentally performing well under current circumstances – e.g., AMZN, MSFT, GOOG, NFLX, etc., and 2) there is a material possibility that consensus expectations are too negative.”
Expanding on the first point, 20% of the S&P 500 is comprised of only five companies (see charts below). These five companies carry as much weight in the index as the bottom 350 companies. In the initial aftermath of March’s market rout, these five companies rebounded quickly, with Amazon even reaching a new high. The danger lies in the fact that these five companies can only be bid up so high.
The five largest stocks account for 20% of the entire S&P 500, a level of concentration not seen in almost fifty years.
These five largest companies carry the same weight in the S&P 500 as the bottom 350 companies combined. Thus, 20% weight for the top five, 20% weight for the bottom 350, and 60% weight for the middle 145 companies.
The market is already pricing in a fairly quick and solid rebound. It seems there is plenty of room for downside surprises. In any event, we should expect continued high volatility and a long grind of uncertainty. Thankfully, our TimingCube models excel in this type of uncertain environment, having profited once again as the market ran aground.
Stocks ultimately spent the week consolidating the rebound recovery from the March lows as earnings reports poured in. However, there were fireworks to begin the week. Monday kicked the week off with a shocking negative price for immediate delivery of a barrel of oil as oil storage facilities were completely full. The dysfunction in the oil market sent stocks lower by -1.8%. Stocks accelerated their downward slide Tuesday with a -3.1% drop. Once more, the enormous oversupply of oil in the face of a plunge in demand caused investors to question the pace of a possible economic recovery. Semiconductor stocks suffered steep losses Tuesday, an indication of the negative economic outlook. From that -5% drop over the two days, investors stepped in Wednesday to buy the market decline and send shares heading back upward. Earnings from market leader Netflix (NFLX) were solid enough to encourage the bullish feeling for tech and consumer stocks. Stocks closed with a +2.3% rise Wednesday. The positive tone wandered into Thursday with another incredibly high unemployment number hitting the wires. However, stocks seemed to take the number in stride as it was a touch lower than the prior week, suggesting that perhaps the worst of the unemployment figures is behind us. But the early rally gave way on news that Gilead’s coronavirus drug “flopped” in its first clinical trial. Stocks slid from a +2% gain into a flat close on the news. Friday found stocks mounting a late-day move higher to close with a +1.1% gain on the day. Oil prices suffered their worst week on record, but rebounded over the latter half of the week to help investors find their footing. Meanwhile, Congress agreed on another round of aid for ailing small businesses also helping support the market.
The recovery over the back half of the week was not enough to completely restore the stock indexes, with the S&P 500 (SPY) slipping -1.28% for the week. The Nasdaq 100 (QQQ) fared a bit better with a -0.67% loss. Small-cap stocks (IWM) outperformed for a change adding +0.29% over the week.
Warm wishes and until next week.