The Drivers of the Stock Market Rally
- Massive Federal Reserve and fiscal policy response and supporting programs
- As well as progress on virus/medical side in flattening the curve.
- Daily U.S. cases is flattening in aggregate.
- This is happening in Europe too, which is ahead of the United States in the timeline.
- Caveat: These positives don’t mean further declines are not coming.
- Bear market rallies are common.
- They commonly retrace half the initial decline, so the current rebound is not unusual from a technical basis.
- The economic data have been terrible.
- Another 5.6 million in unemployment claims
- Massive cuts to GDP forecasts
- The market is discounting Q2 being a disaster and a recovery in Q3.
- The economic side still depends on the path of the virus.
- We are not epidemiology experts, but it seems clear we’re so far behind in testing to know the overall exposure that there is risk in reopening and getting back to work too soon.
- We view it as a time to still be cautious: We don’t think a V-shaped recovery is the most likely path.
- Seems overly optimistic given the unknowns on medical side, plus the unknowns from the behavioral change side once restrictions are lifted.
- There is likely to be a lasting effect on consumer spending (decreases) and savings (increases).
- This also applies on the business side to capital expenditures and employment.
- As global supply chains are called into question more, corporate profitability and earnings could be hurt.
- Huge amounts of stock buybacks are no longer supporting the market.
- The Federal Reserve has gone this far; no reason to think they won’t buy S&P 500 ETFs.
- So depth and duration of recession, timing of recovery, remain uncertain.
- Virus path, testing, and treatment clarity will give a clearer picture of the impact than investor psychology.
- The significant shorter-term significant risks remain top of mind for us.
JPMorgan Strategic Income Opportunities (JSOSX) Webcast with Bill Eigen Notes:
- Approved fund on the Recommended List.
- He has a few side businesses (one is an auto shop); though anecdotal, he shared the impact he’s seeing in these businesses:
- The impact has been worse than in the 2008 financial crisis.
- During the worst week back then, the auto shop worked on three to four cars a day.
- Over the last five days, the shop had worked on only two cars.
- He tried to tap the small business assistance from the CARES Act but found the red tape and process impossible and gave up.
- He is skeptical the money is getting to where it needs to go and in a timely fashion
- He thinks people are underestimating the situation.
- His fund was 40% cash before the selloff; Eigen started buying in mid-late March but stopped buying when spreads snapped back.
- The fund now has a high-single-digit allocation to high-yield and structured credit.
- Conservative, top of capital structure, not reaching for yield
- Eagan thinks 1500-plus spreads on high-yield above Treasuries is possible and doesn’t think it’s attractive at current levels.
- He has initiated some shorts in the portfolio.
Call with Ken Shinoda, DoubleLine Portfolio Manager
- Shinoda’s focus is non-agency RMBS.
- They’ve seen some catch up from securities that aren’t part of the Fed buying programs.
- There is still a big bifurcation, though.
- They’ve seen remittance reports come in a bit better than expected so they think there is a lag in what’s to come and how negative it can get.
- There remains a lack of liquidity and in the depths of March there were no bids on less liquid paper, making it not a good environment to sell or try to reposition much.
- Still significant bid/ask spreads. Can’t really recreate a sizeable portfolio at current marks because sellers that weren’t forced to sell won’t transact at quoted levels.
- Still somewhat dysfunctional market where the Fed is not involved, although improving significantly
- There will be impairments in a lot of asset classes, but they’re confident that securities they own will keep cash flowing.
- It’s the best environment they’ve seen in 10 years on forward-looking basis.
Note on the Corporate Distressed Opportunity Set from a Credit Manager We Follow
- The manager is expecting a $1 trillion stressed/distressed opportunity (including leveraged loans and original high-yield bonds, as well as fallen angels).
- They estimate there is only $200 billion of distressed dry powder waiting on that opportunity.
Harris Associates’ Working Assumptions (Subadvisor to the Oakmark Funds)
- Their global/international teams are assuming things will normalize in 18–24 months.
- This may be naïve, but that’s their working assumption.
- Bill Nygren, portfolio manager of Oakmark Select (OANLX) and other funds, notes that something similar is being assumed on the domestic side:
- They are asking analysts to model 2020 as a wash, 2021 as a partial recovery, and full recovery by 2022.
Asset Class Thoughts
- On the U.S. stock side, not changing our assumptions makes sense since information seems to be priced in.
- Our earnings estimates were already conservative vs. consensus, so we are still happy with our estimates looking out five years.
- Our int’l allocation has a value bias with a lot of cyclical exposure.
- Mark Little, co-manager of Lazard International Strategic Equity (LISIX) said “most value not defensive, but most defensive names aren’t a value.”
- The trick is trying to balance that.
- No change in European stock return expectations.
- But Europe is still hesitating to go all the way on fiscal stimulus and support, unlike the United States.
- It is unknown what stresses will be seen as EM companies open up.
- There is a lot of headline risk.
- Bottom line in EM from what we see is the problem might be manageable.