- 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.
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.
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.
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This article was written by
Mott Capital, aka Michael Kramer, is a former buy-side trader, analyst, and portfolio manager with 30 years of experience tracking market fundamentals. He focuses on long-only macro themes and studies trends and unusual options activities to identify long-term thematic growth opportunities.He leads the investing group Learn more .
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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.
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