April 2, 2020

The pandemic has forced us off the rails. It feels like we're all passengers on Ozzy Osbourne's Crazy Train. I'll spare you the Black Sabbath version and instead turn to the more mellow, bluesy Bob Dylan version of how it feels when your train gets lost.

Traditional economic and stock market indicators aren't working

Take GDP for example. I've seen recent estimates that GDP could come in at a negative 15% in the second quarter. That would be a depression scale number. I've also seen estimates of negative 4%, which might be closer to what we really get.

But my point is that these estimates are really nothing more than guesses. We all know that the final number is going to be bad, so the relevant question is which estimate has the market already priced in? 

If investors expect a 15% decline in GDP and the report comes in at 4%, we can expect a huge rally in the stock market. But then we have the third quarter number to deal with. If you're an optimist, the third quarter will be less bad than the second quarter. What will happen if it turns out to be worse?

Earnings Estimates

Before we went off the rails, estimates for 2020 were about $178. Analysts are notoriously slow to change their estimates. I'm seeing numbers recently in the $150-$160 range and that's way too optimistic. Closer to the truth is $120-$130. Put a 16x P/E on that and you get 1920-2080 on the S&P 500. Ouch.

Unemployment

Estimates are all over the map. I've seen numbers as high as 25% (again a depression scale number) and as low as 6%. I could drive a double-wide trailer through that spread, and many current homeowners will be doing just that.

Inflation

I've read scholarly articles that posit we are headed for deflation, not inflation. And they might be right. But the powers that be (policymakers) have a vested interest in creating inflation so that we can pay off our massive sovereign debt with cheaper dollars. I'm in the inflation camp.

Asset Class Returns

The table below comes from James Picerno of The Capital Spectator website.

Picerno asset class returns

The damage done thus far has leaked into the 3 year return numbers. There are very few places to hide in this market. Cash, as they say, is King. TIPS offer a modicum of protection against inflation. The other asset classes are up for grabs when it comes to planning ahead.

At the bottom of the barrel are REITs. They are being forced by margin calls to sell assets into a no-bid market. Many will not survive.

Final thoughts

The Crazy Train we're on is causing extreme mispricing of risk. Oil at $20/bbl? Big Tech down 25%? Cruise Ship operators down 65%? Las Vegas Casinos down 46%? Retailers down 57%? Small business failure rate, especially among resorts, restaurants and bars, approaching 20%? Do these seem like rational numbers to you?

The problem is that things could get even worse before we finally hit bottom. I have confidence in my call for 2000 on the S&P 500 as the bottom, but that could change as conditions change.

If you aren't sure about what to do next, contact me at info@zeninvestor.org and we can schedule a consultation.

About the author 

Erik Conley

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

  1. Thanks Eric, keep it coming. We’re starving for good information out here.

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