It is astonishing when one peruses global market benchmarks to see that the S&P 500 is only down around 9% year to date, in a year that has seen 30 million Americans out of jobs, Q1 GDP down 4.8%, and a Q2 so horrific that most companies are shying away from giving any guidance at all. It is as though investors are looking past these two quarters as a one-off, intoxicated by the Fed-induced unlimited Quantitative Easing and asset purchase program. They are almost expecting a V-shape recovery.
The Fed's liquidity can support markets, no doubt, but it cannot print its GDP. The market has been obsessing over the global rate of peak infections, waiting for it to pass and start declining to confirm that the worst is over. As most countries come out of lockdown mode in May, opening their economies slowly, markets have rallied 34% since lows in March, but now what?
It is one thing to say that economies are slowly restarting and businesses opening up. But to suggest that life or spending will go back to where it was at the beginning of the year is another matter altogether. As the near-zero demand levels of March and April, it is obvious that there is some demand return, but it will still be subdued. We have to now live in a post-covid world where consumers will be more cautious and travel jet fuel demand a lot less.
The economic prints get horrific day after day -- from PMI, to ISM and employment numbers. U.S. Factory Orders (month on month) for March came in at -10.3% vs. 0% previous. Durable goods order for March reported at -14.7%. It is not just the U.S., even the eurozone is seeing some shocking numbers recently.
Those who expect life or demand to return back to normal by Q3 seem overly optimistic. This ties back into Oil demand, and U.S. consumer and business spending. Despite the Fed's liquidity injection, the banks are hoarding the cash and lending standards have tightened. Chase, as an example, now requires a credit score of 700 for all new home loans. Under new lending standards, about 25% of current borrowers would not qualify. There is still stress in the system, which can be exacerbated if those jobs do not return, putting pressure on the Housing market.
Given endless money printing by global central banks, inflation is certainly going to be a theme. For now, the market is focused on deflation, given lower asset prices and lower growth. But this is already evident in food prices, as global supply chains are disrupted. Beef prices are up 60% from their February lows to a record of $331 per 100 pounds. Wholesale prices have soared 8.6%, doubling in less than a month. There are various grocers that are limiting the amount of meat purchases consumers can make. At a time when there is no hint of jobs coming back and inflation is evident, this can slow consumer spending patterns a lot, added on by mortgage and refinancing risk.
Another risk not being talked about is the sudden pick up in angry rhetoric by President Trump towards China. Clearly, they are trying to hold China accountable for the mishandling of the Coronavirus breakdown and certain facts. Hanging onto the "greatest economy ever" is no longer valid as the U.S. undergoes serious recession risks. The most tactical strategy is to make someone else the scapegoat -- his all-time favourite punching buddy, China. There is no way China will pay any compensation for this pandemic. Trump went as far as to suggest that he could slap on new tariffs of up to 25% tax on $370 billion of Chinese goods, or new sanctions. Phase 1 "trade talks going well" is a thing of the past. After the healthcare crisis, if the heated debate between these countries pick up, this trade war risk is certainly not being priced in either.
Beijing is preparing for President Trump to strike as a worst-case scenario of armed conflict with the U.S. That is an entirely frightening matter altogether. Last week, China's central bank launched its first e-digital official currency, pressing ahead with its plan to roll out a virtual payment system, potentially moving away from the dollar reserve currency status. It is being tested in four cities before being rolled out. We all know this is an extremely sensitive issue for the U.S. as the rising threat of China as a global super power has always threatened U.S. foreign policy.
To date, 55% of companies have reported earnings for Q1 2020. With 65% of companies beating their EPS estimates, it is well below the five-year average. However, beating already lowered expectations is not entirely a difficult task. And 22% of the S&P 500 market cap is driven by a handful of five stocks. Despite their beats, the outlook is uncertain. Market valuations are not cheap on a 12-month forward basis. This market is driven up by complete multiple expansion and the "E" of the P/E looks debatable.
Perhaps it is time now to focus on how quickly demand can return, despite all the assets the Fed is going to have on its balance sheet. After the rigorous purchases in March and April, the amount of Treasury and MBS purchases is slowing down. This has been a big support for the Equity market. Perhaps the old adage, "sell in May and go away" will be valid after all?
