There’s an old joke on Wall Street that investors like to say that they invest with a long-term mindset. It’s just that long-term means only until the next bear market.
Stock is a claim on a company’s assets and future earnings. There are a bunch of different ways to estimate what a stock is worth, but part of the input is going to be an estimate of future earnings. This sort of thing is fascinating because obviously we don’t know what the company’s future earnings will be. We can only guess. Looking at a company like Tesla, it seems that the market has been pricing in strong growth for several years. A company like Apple might have a less volatile stock price because the earnings are more consistent and easier to model. If the cost of a component in an iPhone goes up, analysts can adjust their expectations relatively easily. Meanwhile at Tesla, if you’re pricing in big growth several years out, who knows what effect the cost of a component will be? The margin for error is wide and so is the volatility.
That’s an over-simplification, but an interesting lens to view today’s market through. The bull market has ended and we are now in a bear market (drop of over 20%). The way stocks are being repriced, though, makes me wonder just how far out the market is looking as far as earnings go. COVID-19 and the oil shock will definitely have an impact, but over the short to intermediate term for most companies. I would expect airlines, cruiselines, casinos, and other tourism stocks to be hurt more than most – and they are – however, we’re still seeing some big drops across the board. Has the market’s definition of ‘future’ in future earnings shrunk? It’s almost like it expects an infinite global quarantine.
This has turned from a market of investors to a market of traders and now speculators. If you’re only modeling earnings out to the first round of the NCAA basketball tournament, then yes things look dire. I recommend against extrapolating the last two weeks into the next 10 years.
The S&P 500 tripped a circuit breaker on Monday and then again today (3/12/2020). The market takes a 15 minute break if it’s down 7%. There is another at 13% and another at 20% which would end the trading day. We’re seeing big daily swings up and down which tend to happen more in bear markets – a big up day is not necessarily a good sign. Quarantines and event cancellations are rolling across the globe, putting a halt to economic activity. Oil has crashed down to $30/barrel – not ideal if you need high $40s/barrel oil to make a profit (US shale).
Unemployment is incredibly low at 3.5%. Inflation is tame and likely to drop with energy costs. Interest rates are at rock-bottom. Oil has crashed down to $30/barrel – ideal if you use fossil fuels to power your car, machinery, or electricity.
What Do I Think
The bull case items have been signals to back up the truck and buy in the past. The bearish items are events rather than extended structural changes.
One odd thing about this bear market is that we know the causes and they are quantifiable. That is, we can see quarantines get put in place or lifted. Oil demand is a well-followed data point. We will know when the Saudis reduce oil production. This may be the least uncertain bear market ever, giving cover to kitchen-sink problems for many companies.
Is this a buying opportunity? It’s an opportunity to execute on your financial plan. Is your asset allocation out of whack? Whack it. Does it make sense to harvest losses? Grab a scythe. Are you close to a hitting a rebalancing trigger, but not there yet? Feel free to wait. I won’t tell you what to do, but I can tell you what not to do. Don’t panic trade. You already did the hard work of putting together a long-term plan back when things were boring. Having that plan should help sharpen your judgement and make executing the plan easier, even if that means not doing anything. The last thing you want to do is get in your own way.