Double Shock

Double Shock

3/21/20

Investors looking to jump back in may be too early. The market went on sale this month, but only off of peak valuations. It is commensurate with the "value" most shoppers find at discount retailers and factory outlet malls. Inherent value is not equivalent to discounted prices.

And that is exactly what we are witnessing in the markets today. After a decade long post-2008 bull market driven by discounted rates, cheap money, a Fed put, and corporate buybacks, we are now seeing the deleveraging effect on the other side of the hill. It always falls off faster, quicker, and steeper than the climb up. And it will continue... in the short run. 

It will continue because the market is a function of 3 factors: (1) The supply of stock, (2) The demand for those shares, and (3) The economy. Global supply chains are frozen due to the Coronavirus, and the demand for non-essential products grinded to a halt. Companies across the globe are instituting their disaster plans. They are focused on preserving liquidity, not growing their companies. 

The supply of stock is not increasing as private companies are not even considering going public; but the supply of stock available for sale on the market is growing faster than the scary charts CNN is showing on the proliferation of the virus. This is partially driven by the near term outlook, a rush to liquidity over the uncertainty, fear from the prior banking crises, and forced selling from 401-Ks. Most Americans live paycheck to paycheck, so when their job prospects look grim, they must sell their equity portfolios regardless of valuations. 

True this is the environment Warren Buffet and other value investors love. True that valuations are certainly more reasonable today than at any time over the past few years. True that buyers today will perform well over the next decade if they buy and hold high quality shares. But the double supply and demand shock that is still in its infancy will prevail in the short term. 

A downside $150-$160/share EPS for the S&P 500 is reasonable given 1-2 quarters of material economic contraction. A downside multiple of 14x is possible. In 2008 it briefly dropped much lower, but interest rates are now at record lows, so spreads imply a more reasonable bear case S&P multiple. At 14x $150-$160, the downside for the S&P 500 in the double shock we are experiencing is 2,100-2,240. The S&P closed on Friday just over 2,300. We are getting close to attractive buying levels, but build your shopping list and wait a little longer. Do not be fooled by the intermittent pops from short term volatility.

     

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Markets are Adjusting

Daniel Shainberg
January 22, 2019

Stocks tank as economic jitters intensify. The S&P 500 shed 1.4% and the NASDAQ dropped 1.9% as the blame was placed on weak Chinese economic data, a lack of progress in negotiations for a U.S. / China tariff deal and further weakness in housing numbers, specifically new home sales.

Existing home sales in the U.S. tumbled to a 3-year low, baffling brokers who have yet to understand the correlation and impact of rising rates on home affordability. The National Association of Realtors said that existing home sales declined 6.4% to a seasonally adjusted annual rate of 4.99M units in December. Rising mortgage rates and tight inventory are not a healthy mix for sales volumes, and the continued federal government shutdown is not helping.

Today’s news though is reflective of the broader trend in the economy that investors have started to “price into” the equity markets. Namely, that the likelihood for a domestic recession after a decade long bull run is growing more intense, a message echoed by Bridgewater’s Ray Dalio. Dalio warned Tuesday that there is a “significant risk” of a recession by 2020. Once factoring in the potential for a reversal in the multi-decade trend of declining interest rates, the CAPE ratio on the S&P 500 suggests a multiple that needs to correct lower. As we have said before, if risk free rates are trending towards the 4% range, risk assets such as publicly traded equities need to adjust to factor in the required risk premium. Assuming 400bps of incremental return, an 8% implied earnings yield on $175 per share of S&P 500 earnings would put a median price target on the S&P 500 at about 2,200 for another 15% selloff, and that assumes no degradation in earnings quality.

Dan Shainberg

#DanShainberg

#RecessionResister
@DanShainberg

The Next Recession Will Start ....

Daniel Shainberg
September 13, 2018

One of the most famous perma-bears is economist and NYU professor Nouriel Roubini who stated today that "although the global economy has been undergoing a sustained period of synchronized growth, it will inevitably lose steam as unsustainable fiscal policies in the US start to phase out. Come 2020, the stage will be set for another downturn – and, unlike in 2008, governments will lack the policy tools to manage it." How in the world does he know that? 

It is true that we no longer have the same policy tools as our national debt and leverage ratios are stretched. But calling the timing of the next recession? That is silly, and it's no wonder it came from the economist who had the timely call on the day of the post Lehman market low forecasting another massive leg down! On the exact day of the market bottom in March 2009 Roubini was extremely bearish. Those listening to this self appointed market guru missed the greatest rally in 70 years. Again in 2010 Roubini warned that "stocks are likely to continue their aggressive decline and shed another 20% as the world economy weakens." He continued "there are some parts of the global economy that are now at the risk of a double-dip recession. From here on I see things getting worse." 

A broken clock is right twice a day. And Roubini will be right about another recession but not because he has a crystal ball on the future of the economy. It will come because it always does. That's capitalism: Bulls & Bears. Greed & Fear. 

The most we can do as investors is prepare for the inevitable. Those who get carried away with the momentum hype may see their profits disappear quickly as we have seen with the dot-com, housing and most recently, the crypto boom & bust cycles. Some people like to ride stock trends thinking they can liquidate their positions as soon as volatility enters. This is a dangerous way of thinking although it could make you look and feel smart for awhile. 

The beauty of value investing is that while short term pain is always to be expected in the stock market, over a 5-10 year period, value investors can rest assured that if there diligence and research is even mildly accurate, they should see decent risk adjusted returns. 

John Kenneth Galbraith was one of our most famous economists. Commenting on the ability of economic forecasters, Galbraith stated: We have two classes of forecasters: those who don't know - and those who don't know they don't know. 

Warren Buffet also has great quotes about forecasters: "A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting."

Here's how I think of it... I do not know what I'm going to do next week. I certainly have no clue what you will do next week. How in the world am I supposed to predict the the behavior of the equilibrium of the entire world's outlook well off in the future. It's silly. The next recession will happen. Nobody knows when.  

Dan Shainberg
#DanShainberg
#RecessionResistor
@DanShainberg