Stocks Are Pricing In The Wrong Type Of Recovery

Summary

• A V-shaped recovery is very unlikely.
• The market will need to reprice at some point.
• The impact could be worse than expected.
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The second quarter is shaping up to be a bigger mess than many expected. The latest data from the Atlanta Fed GDPNow model is forecasting that the second quarter will see a contraction of 53.8% on an annualized basis or a quarter-over-quarter drop of nearly 13.5%. It would shrink the entire US GDP to $16.4 trillion from $18.9 trillion in the first quarter. The GDP stood at $19.2 trillion at the end of the fourth quarter.

Big Rebound Needed

Make no mistake. This is an incredibly steep decline, and rebounding from this type of drop is much harder than it seems. For example, the US GDP would need to rebound by 62% on an annualized basis in the third quarter just to get back to the first quarter reading, and an additional 6% in the fourth quarter just to get back to where we were in the fourth quarter of 2019.

According to the ASA data board, the outlook, fortunately, is better, at least to some. The data suggests just a 31.7% decline in the second-quarter GDP, which would make things easier but not perfect. The third quarter would only need to rebound by 34% for the "V."

These are mind blogging numbers, but unfortunately, there is no right way to do this. If you can genuinely believe that the US economy can make a real V-shaped recovery and put up those type of numbers, then you are good, you have nothing to worry about. Stocks will recover and probably keep going higher.

However, I don't believe that is possible. I live in NY, and we represent about 8% of total US GDP or $1.7 trillion per year. I'm rather sure this state is not running at 100% capacity, so right there, that's a problem.

CBO

The Congressional Budget Office doesn't see a likelihood of a V-shaped recovery, either. They are looking for something more like a check mark, maybe like a Nike (NKE) swoosh, which is more of what I am looking for too.

(Congressional Budget Office)

Earnings Recovery

The big problem is that earnings estimates are looking for a V-shaped recovery. Although I know "fundamentals" aren't supposed to matter in a Fed juiced stock market, but who is to say a V-shaped recovery in earnings isn't driving most of the move high.

The latest data from S&P Dow Jones shows just that, a massive V-shaped recovery in earnings in 2021. With earnings expected to plunge by 30% this year and rebound by 45% next year to $162.07 per share, it means the S&P 500 is trading for about 19.6 times one-year forward earnings.

It is not to say the multiple is cheap, because it is not. But in a near-zero interest rate world, and massive QE, one could argue that equities deserve higher PEs.

Here's the bigger problem, though, if GDP doesn't recover in a V. Then, perhaps, earnings estimates need to reset, allowing for a longer and slower recovery. If that is the case, then there would be an excellent chance that the stock market would need to reprice.

Earnings and stock prices have a very long history; they tend to like to follow one another. The only thing that tends to fluctuate is how much investors are willing to pay for those earnings.

So, at this point in the game, with a V-shaped recovery not all that likely, it seems like the same V-shaped recovery in earnings is probably not all that likely either.

Now, of course, it is possible that with fewer workers on the payroll, companies will be able to get higher margins from their reduced revenue. It could lead to better earnings down the road too. If companies can figure out the magic recipe to get it down, then the odds of a V-shaped recovery do improve, no doubt. Again, the biggest question is how much of an impact revenue will take and how many costs can companies slash to generate the added earnings. I'm not sure.

Anyway, just a modest take on another topic I continue to think about during these uncertain times.

Watch my interview with Seeking Alpha from June 2 here.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[DWD Investing]

@Mott Capital Management

"Atlanta Fed GDPNow model is forecasting that the second quarter will see a contraction of 53.8% on an annualized basis or a quarter-over-quarter drop of nearly 13.5%. It would shrink the entire US GDP to $16.4 trillion from $18.9 trillion in the first quarter. The GDP stood at $19.2 trillion at the end of the fourth quarter."

In the 'new market' we need to assess things differently. The drop in GDP means the market should rise twice as much. I don't know why, or how it makes sense, but it is what it is. I think maybe if we all stopped working and the GDP went to near 0, the market may be up 1000%.

All of these years I've been using the wrong metrics. Damn.

[bford17]

The issue right now is that there are a lot of people that think the stock market is reflective of the economy. Thats the first mistake. The market is anticipating and overlooking the disaster that will take place in Q2. The million dollar question is whether or not we will pick up where we left off after Q2. My take is that we will not and this "market" will true up at some point because the fundamentals will simply not be there. I know for a fact that my company has pulled guidance for Q2 as many have and banking on stabilizing in Q3. My best guess is that Q3 will still be 15-20% less than 2019 run rates. We will have somewhat decent earnings based purely on cost cutting measures (dollars out of the economy). Wait til PPP expire and businesses have to rely on fundamentals. We will see some people go back to work as we did today, but only 1 in 9 got their job back! This is not something to celebrate! There will be continued layoffs as time goes on, and this will only get worse in the short to medium term. If you are laid off and unemployed, and still spending like its 1999 then you are an idiot, something has to give. In summary, the Fed can put a bandaid on this and buy time hoping that we return to normal, which is obviously what the market is pricing in. When this doesn't happen, it becomes an obvious bubble, and the correction will be even more worse than it has to be. We are a car that went off the road, turned the wheel and sliding back across the road. We may be on the road, but that doesn't mean you have control of your vehicle. I haven't even brought up the short term technicals, that we are seeing, good gosh they look ripe for an 200-300 point SP correction, and thats even with a bullish trend. The fact that the market is currently where we were at the end of December 2019 is laughable.

[MadoffsHoneyBuns]

The government is not going to let a recession happen. They have proven they will stimulate the economy when it gets bad. The treasury and the fed are propping up home prices right now. What’s going to bring the economy down. They will pass another 2-3 trillion dollar bailout package. Interest rates near 0 and government bailouts equal stocks rising fast.

[kbaba]

The Government "prop up the market at all costs" only likely to last until the elections. Not sustainable forever. Whoever wins, the market crashes sometime after the election.

[Greenhorn Investor]

It will be interesting to see how the remainder of the year plays out b/c I don't see the economy getting back to where it was right before COVID. Something has to give imo.

[EliasMouawad]

@Greenhorn Investor Bears have been exponentially wrong for the past 70 days.

[Purpose_trader]

I keep wondering how people say we shouldn't have a v-shaped recovery when we have all but completed a very v shaped recovery. Dismal economic numbers for one or two months does not mean that the world must come to an end. For those people who are kicking themselves for not buying stocks in march, find the next industry to recover and help yourself to some capital gains instead of wishing and hoping the stock market crashes. thank me later

[mahagen]

@Purpose_trader

People talk about personal incomes and how many of the unemployed are making more on unemployment than they were on regular payroll. What people aren't talking about is the fact that the stimulus checks are advances on tax refunds at the end of the year. They aren't talking about that many in the middle class didn't get stimulus checks. My family sure didn't get a check but yet my wife's earnings went down by 60k this year. That's 60k of spending we won't be doing. A lot of the middle and upper middle class are in the same boat. For those who were earning 6 figure incomes and are now unemployed, they aren't making that on unemployment, I assure you. No one can talk about a v-shaped recovery in the economy with 20 million people unemployed. That number may be higher tomorrow, we shall see. Considering that the savings rate has jumped 6 fold while personal debt has dropped, means people aren't going crazy shopping. You might think the economy has recovered but there isn't an economist in the world who will agree with you. I don't think you will find an asset manager worth any salt at all that will agree with you either. You also won't find a CEO of any Fortune 500 company that will agree with you. Right now, it looks like consumer spending in the aggregate has dropped about 30% y/y. That isn't going to return immediately until the job situation drastically improves. The unemployment problems we have today are not unlike 2008 where jobs were lost for no reason other than a recession driven by consumer fears. Once people were layed-off companies weren't quick to rehire. Same as today, every business is looking for ways to trim the fat and reduce headcount to meet a new lower consumer demand. It took 10 years for the job market to recover from the 2008 crisis. I wonder how long it will take this time with almost twice as many people unemployed.

[Purpose_trader]

Very fine points you raise here. Something within me tells me however that market participants somehow have strong faith in President Trump. Some people may think they don't like him but he exudes confidence and hope anytime he speaks (which he does very often), and since sentiment drives the market, that may be enough to help the economy recover. 'Fake till you make it' works, but we shall see.

[canyon]

My five year old daughter speaks with great confidence when she tells me I'm wrong about something like "there's no electrons in that cable" or "the sun goes around the earth".

[MyOtherCarIsACobra]

Aren’t most people talking about the stock market when talking about a V shaped recovery, not the economy?

[Anwar Salem]

@MyOtherCarIsACobra @mahagen Indeed they are, hence, its a bubble. Its all driven by POLITICS, tRump and company propping the market for re-election "ticket".

The stock market by definition is a reflection of the real economy and growth, so do the math, economy is more horrifying that what's publicly reported, LOTS WILL BE HOLDING THE BAG. mark this post

[BioZen]

You would think that by now people would realize that the markets have nothing to do with actual real world economics.

[User 47315847]

You mean “have priced in”.

[canyon]

I had to go back and check the article date. Don't most the stock market charts have a V?

I'm not saying we don't go back down (gap in the 2500s anyone?), but even my 5 year old would call that a V not a U, L or W (yet on the latter).

[papita]

you live in NY State, that's hour first problem, and a big one. with a far left radical mayor of NYC and a more moderate, but still left governor who has kept the state on lockdown and will for the forseeable future, NY stands no chance. Thankfully, I live outside of NY State and my area is thriving. Restaurants are jammed, parking lots are full and people are out. Guess it mattwers from where you are seeing things.

[rosko_pete]

TOO MANY OF YOU ARE IGNORING THE FACTS AND THROWING CAUTION TO THE WIND. IT'S THE CALM BEFORE THE STORM. THIS IS NOT A COMMON VIRUS AND IT IS SNEAKY DEADLY!

[Abel+]

@rosko_pete
There is no virus mate. It is has been a disgusting hoax from the UN and the Committee of 300. Was just another seasonal flu.
What IS deadly, is the sheer attention and obedience the people have on media and government.

[DWD Investing]

@Abel+

How did they get all of those other people onboard who are testing the virus to go along with them, US State, County, City, every single country in the world, Universities world wide , private sector, and all of the rest? I mean, that is some conspiracy - getting millions of high profile countries and scientists to go along with a hoax!

Also, what is their motivation, for the lolz, to shut off the economy, what?

[E.D. Hart]

..empirically, over time, the economy and the stock market are correlated --but currently the two are disconnected in the extreme due to the tidal wave of liquidity released by the Fed.

Liquidity is driving stocks, not the economy, not earnings...

[User 50039191]

People keep saying that but the stocks I bought back in March are certainly driven by current and future earnings expectations and are at reasonable justifiable valuations.

[Corkran]

@papita Yes. Those of us who have seen what a pandemic actually means (some US states plus S Korea, Singapore, HK, Europe etc.) and have had 15% ish infection rates behave and think differently from those who have experienced 1% or less infection rates -- and who irrationally believe that somehow their politics (or whatever) will protect them from a virus with a high transmission rate. I wish you good luck and sincerely hope that you and your loved ones don't die from this terrible, terrible disease or suffer through its worst effects which are devastating. In our town, the first victim was a 44 year old father of twin girls who was in a medically induced coma for three weeks. He's not ok, obviously, but he's grateful to be alive. WAKE UP.

[Anwar Salem]

Sure, its a like a paycheck, when you get it you spend it, then what.... you need another one to spend, and so on..

Unless the Fed is ready to keep feeding paychecks to Mr. market for ever, at least next 5 years, the market should correct to reality.

[jddc]

How does the economy gRow 62% q over Q, if there are so many newly unemployed people ? Who is going to buy “stuff”?? Thus is going to end very badly Jay Powell or no jay powell.

[Kajoobies88]

The unemployed are making more money now than when they worked. Parcel volumes are through the roof at UPS, FedEx, USPS, Amazon, etc. Just wait until that runs out in July though.

[Me XMan]

It's all started with JPOW! POW! POW!

[anon_cowrd]

What has recovery got to do with stock market?

[User 50039191]

How can a v stock recovery be unlikely when we've rocketed 40% in just over 2 months?

[omarakthar]

I think he's hoping for some kind of double bottom action

[joyzoey]

W might be possible.

[groundpounder]

Tell them!!!