Dalton — I don’t see a lot of upside for equities for the next few months. I mean, sure, if we get to a low in the market and you measure it from there, then that will probably be an excellent return. But let’s not play games. The stock market has gotten ahead of itself.
Additionally, as I pointed out in early October, since September 8, the number of daily COVID-19 cases in the U.S. has been trending up and threatening the much-dreaded “second wave.” That doesn’t mean that businesses will necessarily get locked down more tightly. Still, it certainly doesn’t effectively argue that America will be getting back to work any time soon.
The most significant technical headwind for stocks is that everyone who has wanted to buy stocks has done so. As a result, that means that there is less cash to pump up stock prices. In other words, investors are overly optimistic, and typically it pays to bet against the crowd at extremes.
According to the Advisor Sentiment survey, the percentage of those advisors falling into the bullish camp has reached 60.6 percent. That percentage is meaningless to you without some reference. The last two times the percentage of bullish advisors got nearly this high was August 2020 and September 2019. After having reached those lofty levels, the stock market corrected almost 10 and 20 percent, respectively.
These bullish percentages are in the danger zone. As I write this column, the S&P 500 is down almost 8 percent. This correction could be almost over or not. I never could time these short-term swings (and whoever says they can probably has a bridge in Brooklyn they want to sell you). Typically I am not concerned about what might happen over the next few weeks for the stock market. However, I AM worried about what might happen over the next six months. With a stimulus package temporarily scrapped, such extreme levels of optimism make it harder for me to see a pathway to much higher stock prices for the months ahead.
The number of new COVID-19 cases has also spiked into the danger zone.
According to Dr. Scott Gottlieb, former commissioner of the Food and Drug Administration, the U.S is “on a trajectory to look a lot like Europe.” He believes that the U.S. infection rates are only three weeks behind Europe.
Just before I grabbed my keyboard to type this column, Germany let us know just how bad that could be. Germany’s Chancellor Angela Merkel said Oct. 28, that she will impose a one-month partial shutdown starting Monday, November 2. This will be the country’s toughest lockdown since spring. To regain control of the spread of COVID-19, Germany will close bars, restaurants, gyms and theaters. Also, the country will restrict nonessential travel and not allow business travelers to use hotels.
A few hours later, French President Emmanuel Macron imposed new nationwide lockdown measures in response to surging coronavirus cases. People will only be allowed to leave their homes for medical reasons and to perform essential work. The lockdown will be in force until Tuesday, December 1, then reassessed every two weeks.
Hong Kong has announced new restrictions. And the United Kingdom has announced it may impose further restraints.
Regarding Germany’s lockdown, Chancellor Merkel described an aid package for businesses with fewer than 50 employees. The German government will cover up to 75 percent of sales lost due to these new restrictions. Bigger companies will also receive aid dependent upon the limitations of the European Union. That didn’t seem to be enough for the German market, as its stock index, the DAX, dropped more than 4 percent that day.
So far, Germany’s stock market has dropped about 12.5 percent in the weeks leading up to this new shutdown announcement. The stock market in France is down nearly as much. I don’t think it’s foolhardy to consider that the drop in the U.S. market could match the price movement of foreign markets thus far.
Beyond Europe, last week, China reported its highest number of daily cases since April. And Japan hit an all-time daily high. We are looking down the barrel of a global second wave of COVID-19.
I don’t suspect that the U.S. will get back to the level of lockdown experienced in the spring. I don’t feel as if there is a nationwide appetite for it. So, I believe that another coronavirus-induced 40% stock market crash is unlikely. However, we don’t need a national lockdown to affect seriously the trajectory of economic growth.
The drop in U.S. prices might only be halfway complete. I’m glad I maintained those hedges I’ve been writing about. I’m not ready to lift those hedges yet. The direction of the stock market, for the time being, is back in the hands of the coronavirus. In the days or weeks ahead, I may consider getting more conservative again because no one can get a handle on infection rates. It may be worth the cost of taking out some insurance.
Another problem is that earnings expectations for the first half of 2021 are in the danger zone. Estimates for the growth of earnings per share of the companies that comprise the S&P 500 index are 15 percent year-over-year for the first quarter of next year. The estimates for the second quarter are an astronomical 45 percent. Without a fiscal stimulus package, I don’t see those numbers as achievable. Earnings for companies are going to disappoint, and the stock market will not react positively.
This article originally appeared in The Berkshire Edge on November 2, 2020.