After an impressive U.S. stock market rally during this coronavirus shock, we should ask ourselves, is this time different?. Could we quickly recover from a +10% unemployment jump in a blink of an eye?
Have we found the magic formula to cure financial shocks for good? It is tempting to believe it. But as Sir John Templeton once commented, the four most expensive words in the English language are "this time it's different."
The U.S. stock market (S&P 500) has come back above the 2,700 on April 7th, almost +20% up since the lowest level of March 23rd. Most likely, the stock markets are in a reasonable range of fair valuation for 2020 estimated earnings if we account for a moderate coronavirus shock, which it suppose the U.S. can lift the lockdown by the end of April.
The cyclical sectors have started to recover from recent price drops. The financial analysts believe, and rightly so, that cyclical companies earning will be below expectations. But the extent of their business deterioration is still unknown to the markets, and many analysts forecasts see significant losses ahead.
Today investors community expects that technology, health care, utilities, and communications earnings will fare a little better than cyclical. Still, we may realize these facts are already included in the prices, as they have hold prices better.
The coronavirus lockdown presents real challenges for our economy. Besides the health emergency, there are financial damages that will require swift action to mitigate them.
Among then, the increase of corporate debts to a new all-time high will increase companies' risks and cause a deterioration of their credit quality by rating agencies. Most likely, corporations will pay higher interest rates; in the short term, there will be opportunities for those investors who can separate the wheat from the chaff.
The quick unemployment rise in the U.S. reached already higher levels than in the last great financial crisis of 2008. More than +10% unemployment, and it looks like there is more to come. The U.S. government is assisting the unemployed, increasing the time and amount of the benefits, and providing loans to small and medium businesses, if they keep employees in payroll.
The new guideline that will enable the forbearance of payments of mortgages, leases, and other loan payments will reduce the stress for many debtors who lost their jobs. It might also create a conflict of interest with those debtors who do not need it but will use it. This behavior might depreciate investments linked to those mortgages and real estate assets, creating issues for those creditors who invest in those assets, as retirees, insurance companies, and retirement funds.
The U.S. government is already beginning to assist those creditors in avoiding significant financial stress. However, investors will need time to assess the full extent of the impact of these assets.
The current financial stress on corporations caused by the lockdown might create a wave of bankruptcies, for those companies that are struggling to manage their debt loads, and those who will not have access to funding on time. The Federal Reserve is openly buying investment credit bonds, which usually belongs to more significant and well-capitalized companies.
But there are pools of companies who will get their debt ratings downgraded to junk or high yield status. As soon as this happens, these corporate new debts will pay a higher rate. It will not be unheard of that the Federal Reserve might consider in the not so distant future supporting high-risk debt, but there is no news about it yet.
We also need to mind the likely sentiment change of individuals and corporations toward spending. As the economy is going quickly into a recession, people and corporation savings rate might increase. Consumers' propensity to spend might be reduced and delayed. And the enterprise CAPEX investments might also be reduced or delayed. This change might cause a reduction in demand for products and services. It all depends on how long people think this recession will last.
Let us not forget that very soon we shall take a look at companies' earnings for the first quarter. Although it might not show the full lockdown damage yet, the companies' forecasts and their comments in the earnings call will give us a hint.
It might be very likely that companies will cut dividends and buybacks plans. These reductions will not be a surprise to markets. Still, it will have an impact, as one of the more prominent buyers of corporate stocks are companies itself.
The investment community sentiment is also vital. By looking at stock market prices right now, the investors might be thinking this sounds like the effect of a massive snowstorm. They might be thinking it will soon pass, and so the economy will get back on track as quickly as possible. But has this coronavirus shock broken something that will last longer than expected? That it is an important consideration to have in mind.
We will require the virtue of patience to overcome this wall of worries, but it might not all happen in a blink of an eye. Our compensation, as investors, meanwhile it will be the opportunity to buy cheap assets for our future benefit.
Please. Stay safe!
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