Nothing Would Surprise Me — Liberty Wealth

If you are confused by the recent moves in the market, join the club. If you haven’t been following, let me do a quick recap. In February and March we experienced the fastest drawdown in history. The S&P 500 fell 35% in just 33 days (small companies and international stocks fell further). The market hit a bottom on March 23rd. Since then (just a couple of weeks) the S&P 500 has rallied 27% and made back half of its losses.

In February I wrote; ‘my guess is that the recovery on the other side of this will be just as fast as the fall was/is’. I could never have actually predicted that we would make back this much this fast. To put this rally in context, we haven’t had a rally of this speed and magnitude since the 1930s.

That’s the quick summary on the stock market. What about the economy?

We are in dark economic times, and comparisons are now being made to the Great Depression (this is not the Great Depression by the way). Unemployment in the US and elsewhere is soaring. For some context around the rate of jobless claims in the US, please watch this animation - it will blow your mind:

https://twitter.com/lenkiefer/status/1245702858449784832

So, whilst the US unemployment rate shoots up to 15% almost overnight, markets stage their quickest and strongest rally since the 1930.

Makes no sense does it?

Markets rarely make sense. That’s what makes investing so hard. If they did what we expected, we would all be billionaires.

Investing is wildly counter-intuitive - what you most want to do is normally the exact opposite of what you should do.

What people often expect is that the markets will follow the economy, but the stock market is not the economy. Confusing the two is very dangerous.

Here’s quick lesson in finance. To value a company you use what is called a discounted cash flow model. This analysis attempts to work out how much a business or investment is worth today, based on a projection of how much money it will generate in the future. Once you project those cash flows, you then discount them back to the present value. Most of these sorts of models will take the cash flows out into perpetuity. So you’re not valuing a business on this years’ earnings, or next years’ earnings, but on all the earnings that the business is going to generate out into the future.

We are in a situation today where earnings (cash flows) for businesses have fallen dramatically and suddenly. For some businesses earnings for this quarter and maybe next will be zero. For some businesses the pain might go on for longer.

Let’s assume that earnings for the entire S&P 500 were wiped out in both 2020 and 2021. That is, every single one of the biggest 500 companies in the US made nothing this year and next. But from beyond 2021 earnings remained untouched. What would this (academically) mean for the stock market? David Kelly, Chief Global Strategist or JP Morgan Funds, says that it would justify a little less than a 12% decline in the value of the index!

We had a 35% fall.

Now, I am not saying we have seen the worst. I don’t know that we have. Nothing would surprise me from here.

But please don’t forget when listening to the news that the stock market is not the economy. It never was.

Georgie

georgie@libertywealth.ky