SPX 3000+ ? Ten Reasons for the Market Rally
April 9, 2020
As readers know, I have been skeptical of the recent run-up in risk assets so far. In fact, don’t get me wrong, I am not bullish and am overall flat equities. I just want to lay out the case for how we skeptics could be wrong.
Because every smart trader and analyst should be humble enough to question themselves when the market defies their expectations. A simple look back tells us that the market, which , traded on average at 18x TTM earnings (see Figure 1) is trading today at about 18x todays trailing 12-month earnings of $155, which is the average multiple over the past decade.
Figure 1: The S&P 500 is trading at about 18x TTM earnings, even though those earnings are set to plummet.
Source: Bloomberg
Of course we all know that the earnings are about to fall off a cliff. Yet the market is buoyant. So what explains the rally, and what are the chances of it continuing near term, say into Mid-May?
So this blog will outline a list of factors that could drive the Bull market further. It is clear that much of the market move is and will continue to be news driven and technical. Therefore my bias is to emphasize non-fundamental and policy led positive factors for the market.
1. Early announcement or news of another fiscal care package from the Federal government, especially for the consumer and small businesses. It appears that any new package is not close and will be harder to pass, but progress towards one cannot be ruled out.
2. Legal remedies for broken payment chains are urgently needed. For example, can tenants and landlords now sue each other? Will vendors sue clients for delayed payments? How will banks deal with delayed loan payments? How will contracts for payment be enforced? Congress may act on these given the widespread breakage of business as usual.
3. The Fed’s newly announced direct lending plan for small and medium sized businesses is unlikely to be a game changer, but it will help. It includes loans of unto $25 million at 250-400bp over the Fed Funds rate, which is of course at zero currently, a 4 year term, and no payments for a year. Along with PPP, this is surely helpful to tide businesses over as they contend with broken payment chains. But delays and implementation bottlenecks are inevitable, and those breaks seem far more pervasive than programs of this type and size can truly solve.
4. The Fed has just announced the expansion of QE to other assets including High Yield and Municipal bonds. This is a big deal and induced strong rallies in High Yield, Muni, and credit markets in general on April 9. As Figure 2 shows, both stocks and high yield have recovered —to 94 and 96% of their respective levels from a year ago- (not even counting HY coupons).
Figure 2: Both the High Yield (illustrated with HYG) and stocks (SPX) have recovered most of their losses since this time last year. Fed support for bonds may explain much of the HY bond market recovery.
Source: Bloomberg
It would not be surprising if it turns out that we have already seen the low in the non distressed segments of the credit markets- but it is hard to be as sanguine on equities.
5. The Fed, and the passage of time are bringing back further normality in credit and massive long term corporate borrowing, In turn this could bring back the prospects of buybacks and smaller dividend drops.
6. The earlier selling wiped out the over-risked longs, and the latest rally was an asset allocation adjustment. It’s likely that equity allocation is not yet back to prior levels and so moves up may be chased.
7. Earnings are likely to be abysmal but the market does expect that. But a further rally could be sparked by better earnings guidance from companies during the upcoming earnings season, though we are unlikely to see much visibility for the next quarter or so.
8. Of course, not all the positives are technical or due to policy - here are the ones directly related to Covid 19. Thee first of these would be a quick approval/massive rollout plan announced for ppe, testing, cures, and/or vaccines.
9. Sharp infection drop off due to weather or other reasons leads to quicker lifting of isolation protocols
10. Massive drops in death rates due to new and better medical solutions and protocols . Examples include differential treatment for different categories of critical care patients and the use of post-infected donor plasma with Covid antibodies.
If even a subset of the items on this list happen, it’s great news, BUT after what we are going through, the market should still trade at a lower multiple of lower earnings. If earnings and multiples should each be even 10% lower compared to pre-crisis levels, then SPX is above that point already (-20% vs peak! )
My friends, we would do well to remember, however, that the market can remain irrational longer than you and I can remain solvent. Because any of the powerful reasons on my list are possible and can cause further chasing, I’d put the probability at 20% of the market consistently trading above 3000 by mid-May.