For nearly half a year now, pundits have been offering their viewpoints on what the Coronavirus means for both investors and the broader economy. Many have taken to offering prognostications regarding the shape of the eventual recovery. While I find these viewpoints amusing (my personal favourite is the “square root” shaped recovery), I cannot help but note that they are virtually all about the economy writ large. Economic growth. Output. Change in GDP. Employment and unemployment. Basically, these forecasts are about the big-ticket indicators of economic well-being. The thing is – as has been noted by me and by others – the economy and the market are very different things.
The question that one might ask therefore, is about the shape of the performance of capital market indicators going forward. Looking back from about Valentine’s Day, there’s a giant ‘V’ to depict both the TSX and the S&P 500 (and various other benchmarks, too). Is that it? Do we go essentially sideways from here and carry on as if the storm has passed? Is this story five months long… or are other letters on the horizon?
The dominant narrative as of late July is that the story is essentially over. There’s little more to say. The virus will be with us for the remainder of 2020 and well into 2021 at least, but the impact on capital markets HAS BEEN felt and HAS BEEN addressed through a swift, effective public policy response – both in fiscal and monetary terms. In short, the dominant narrative uses the past tense. I beg to differ.
While there can be no doubt that the globally coordinated policy response has indeed been swift and effective, it remains an open question as to whether or not the story has ended. If this was a baseball game, I’d guess that we are now moving into the third or fourth inning. In my view, this is not even close to being over.
My frame of reference has long been the United States. Going back to three gratuitous rate cuts in late 2019 (i.e. serious stimulus measures in light of generational lows in unemployment and normal inflation), I’ve had my doubts about the true motives of the Federal Reserve Board. For over half a year now, the Shiller CAPE for the S&P 500 has been hovering at around 30. That’s about twice as high as the historical average. Stated differently, stocks could plausibly drop in value by half and still be considered fairly priced. Stated differently, that means they are extraordinarily expensive. This extraordinary valuation is during a global pandemic that has caused the greatest economic shutdown since the great depression. Pundits want investors to divert their attention from the gravity of reality toward the happy thoughts of everything being fine. I call Bullshift. That’s where the industry does all it can to shift attention away from facts and toward a bullish sentiment.
The square root sign starts up high, goes down and then comes up about halfway before flattening out. That may well be a fair depiction of what happens to the broad economy, but stock markets are different. For stocks, I think we’re in for a backwards N. To draw the letter ‘N’, one starts low, goes up and then goes back down again. I think the opposite is what we’re in for. Start with a ‘V’ (where we are now) and then go down again. Time will tell, but I don’t think the next major move is up – or even sideways. My view is that the next move will be decidedly downward.