Give it time

I said I was going to discuss the bull case but I'm also going to discuss the bear case and where we may be in this bear cycle.  As far as the bull case, it pretty much goes like this: We are in a manufactured recession caused by an exogenous shock and so once that shock has passed we should go right back to where we left off as there are no excesses to work off like there was with the tech bubble bursting  in 2000 and the housing bubble bursting in 2008. In addition, we now have super accommodating monetary and fiscal policies put in place which are not going to be tapered off for at least 2 years. The 35% drop in the market has cleared away a significant degree of excesses and we've seen some indicators such as the VIX hit extremes which historically have occurred during a time of extreme panic which is where major market lows tend to form. We also have a multi-year low in energy prices which will be another tailwind for the economy and such low energy prices are what you tend to see closer to a bottom than a top.

I would really be on board with the bull case if the lock down that we are currently in was already over. Unfortunately, that's not the case and we're going to be locked down for at least another month and I believe we are beyond the point of no return whereby it's not going to be business as usual once we emerge from lock down and so the bull argument that we'll go back to where we left off doesn't hold water in my book. Until there is a vaccine for COVID-19 there's going to be a notable change in the way we do business and interact with each other. There will be a notable increase in the savings rate of consumers, seniors will be more likely to avoid vacationing and the like. To sum it up, there's  going to be a notable and lingering amount of skittishness in general in the post COVID world until there's a vaccine. Meanwhile, while we are awaiting the recovery, the economic damage is devastating and is increasing by the day. The cascading risks I mentioned a few weeks ago are unfortunately happening because the lock down has simply been for too long for many business/corporations to bear. I've read an article about how 10% of Canada's restaurants/cafes/bars are now permanently closed and this is only after 3 weeks of lockdown. I'm sure there's many other businesses suffering similar fates. It's only going to get worse as the lockdown is going to continue for at least another month it would seem and quite possibly 2. So, when we do get out this it's not going to be business as usual. Governments are trying to do whatever they can to mitigate the damage, but that's all it is - mitigation. How can they bail out everyone and make them whole again?  I know a restaurant owner who's business has declined by 60% which if not for catering would be near 0%. Is the government going to give him a cheque for all that lost revenue? No. However, if the government engages in massive deficit spending in addition to the wage subsidies and support they are providing the unemployed, it will indeed plug some of the gaping hole in GDP that is going to be lost, but certainly not all you can't hold your breath for that.  Before that happens or kicks in we're going to see the biggest plunge in corporate earnings ever and investors are going to have to face the grim reality of this. Yes, the market is forward looking at we're expecting to see bad news....perhaps this is best thing the bulls got going for them in short term. We could be in a situation where there's too many johnny come lately shorts at a time where others think there's "value" in the market and decide to ignore the bad news thinking it's already priced in while focusing on any glimmers of hope. We saw the same thing happen in late March 2001 and in late March 2008 where the market staged a multi-month rebound (almost identical ones)  only to succumb to new lows later in the fall of those years. Such a thing could very well happen again. I'm not saying I expect it but rather that it would not surprise me. If we simply tanked to new lows in the near future I'm not going to be surprised either because as it stands right now I don't believe this bear market is over. The reason I believe that really all boils down to this. We're going to see the biggest economic catastrophe since the Great Depression which as I discussed is not going to result in business as usual once things go back online and so I find it very hard to accept that a 35% decline in the stock market is all that we are going to see when history suggests otherwise. Once again, I would love to be wrong and I'll keep an open mind to all possibilities but I got to call it like I see it. I think ultimately the market will drop at least 50% from the peak which translates to a target of SPX 1700. Why 50%? Well, if the burst of the tech and housing bubbles created a 50% drop why can't the COVID crisis do at least the same when the economic damage will be far greater than the fallout of those 2 bubbles?  Ya, I get it, there will be a strong snapback in activity as there is pent up demand but a lot of damage that is being done right now is permanent which is growing every day we stay locked down. Some of that damage will be offset by fiscal spending but how much and when? Do you want to hold your breath thinking that the authorities can bail out the entire economy? I'm not. And as mentioned before do you think that it will be business as usual once the lockdown is over ? Not for a while it won't.


Here is one chart which gives a pretty good indication as to where we are in the sentiment cycle.

You can see that AAII investors have made a sharp move out of stocks and into cash but it is still not at the dark green level where it was near the bear market bottoms of 2003 and 2009. It suggests pessimism is high enough for a bull market correction bottom but not high enough for a bear market bottom. Again, I re-iterate, if this crisis is at least on par with the tech bubble and housing bubble busts, we should see a similar level of decline in the market from the peak and the extreme level of pessimism associated with it which means for the above chart to eventually touch the dark green line. If I'm right and we still haven't seen the final low, don't think Mr. Market is going to make it easy for bears to profit from it. The motto of this blog still applies. The bear market low could take several weeks or even months to play out which in the meantime the market would have all kinds of short lived rallies to punish bears and suck in bulls. We could very well see such a rally now if people decide to ignore the ugly economic reality for a few weeks and focus on any glimmer of hope of COVID slowing down.

So in conclusion, give it time and be very patient and be open minded. I'm leaning long term bearish short term neutral. If the bull case is going to play out, it would be more likely to see the market behave as it did after the 1987 crash or after the big 2011 drop whereby it spent a few months building a base. But unlike those 2 previous times, we have an economy that is collapsing and that's a very big deal because ultimately stock prices are fundamentally underpinned by earnings and that underpinning will be gonzo for a while and when it comes back it probably won't be as robust as before which to me suggests we're still in a bear market and the final low may not happen until later this year or even a year from now when expectations are sufficiently lowered in the post COVID world. As usual I may adjust my viewpoints as events unfold.