Main Street thinks Wall Street is crazy.
Wall Street thinks Main Street is going to be relatively OK.
That’s the apparent message after the Dow Jones Industrial Average jumped more than 400 points Friday and stocks continued a torrid rebound despite data that the U.S. economy shed more than 20 million jobs in April. Lockdowns aimed at containing the deadly COVID-19 pandemic pushed the unemployment rate up to 14.7% — a postwar high that economists said likely understates the devastation.
Advisors and analysts everywhere have been inundated with calls from clients asking why stocks keep soaring as the economic data grows uglier by the day.
They have a well-worn list of reasons:
- The market is looking forward and has already anticipated a sharp but short recession
- There are tentative signs the outbreak has peaked
- Progress toward treatments and even, potentially, a vaccine
- The Federal Reserve’s unleashing of unprecedented monetary stimulus and lending backstops, and the promise to do more
- A raft of federal spending aimed at shoring up workers and companies
But the test will be whether the consumer — the main engine of the U.S. economy — springs back to life after being virtually, or even literally, shut in during the pandemic.
“It’s all going to come down to consumer spending. If we’re all sitting inside and not out spending money in September-October, the market’s not going to like that — the market will go down,” said Scott Wren, senior global market strategist at Wells Fargo Investment Institute, in a phone interview.
Whether consumers are out and about will, of course, depend in large part on how the pandemic plays out. While infections and the death rate in New York, the center of the outbreak in the U.S., and other urban hot spots have turned lower, outbreaks have worsened in other parts of the country. Meanwhile, several states have begun loosening restrictions or making plans to do so.
“I think 2021 could be a boom year,” Says Wharton Professor Jeremy Siegel
“We’ve seen the lows in March” for the stock market, says the man who called Dow 20,000 in 2015, “and we will never see those lows again.”
That is Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School of Business, during CNBC’s “Squawk Box” segment on Friday. He expressed nearly unfettered optimism about the path forward for the U.S. stock market, despite a historically bad jobs report.
Friday’s monthly report on the employment situation in the U.S. showed that 20.5 million jobs were eliminated last month, sending the unemployment rate to 14.7% from a 50-year low of 3.5% two months ago. However, dramatic as it was, the headline number was less alarming than estimates calling for 22 million unemployed.
Although the government didn’t keep records back then, economic historians estimate unemployment peaked at 25% in 1933.
Still, according to Siegel, unprecedented support for the economy by the Federal Reserve and the U.S. government make it nearly impossible for the stock market to revert to its late March lows.
In fact, the Wharton professor envisions equity markets rising well into 2021 as treatments and vaccines for the COVID-19 disease are discovered. “I think 2021 could be a boom year,” he told the business channel. “With the liquidity that the Fed is adding — unprecedented — it could be a really good year.”
Siegel garnered acclaim after he forecast that the Dow would reach 20,000 at the end of 2015. The index ended that year at 17,425.
The Debate Which Will Only Be Finished with Actions
There’s a debate on Wall Street over whether stock market investors know something that the rest of America doesn’t. At least when it comes to what a post-COVID-19 future looks like.
The death toll from coronavirus is still rising, albeit at a slower rate.
More than 20 million people have lost their jobs since the pandemic took hold in March, with unemployment spiking to a post-World War II high.
Meanwhile, earnings of the S&P 500 companies are falling as if the 2008 financial crisis is repeating itself, and it’s likely to get a lot worse. Never mind the facts, because the S&P 500 index surged 1.7% Friday, and has now rocketed more than 30% in about six weeks.
“[W]e think that markets might be getting a little ahead of fundamentals/economic reality and are pretty close to fairly valued,” said Sameer Samana, senior global market strategist at the Wells Fargo Investment Institute. “That leaves them vulnerable to disappointment on a number of fronts.”
That apparent disconnect between investor expectations and current reality has driven a widely used measure of market valuation to the highest level in 18 years.
The S&P 500’s price-to-earnings ratio, known as the P/E ratio, measures the price of the index relative to aggregate earnings per share of its components. It is used to quantify what investors are willing to pay for the earnings they are getting, or expect to get.
Using earnings estimates looking out over the next 12 months (NTM), the current S&P 500 NTM P/E ratio stands at 20.61, according to FactSet. That is the highest level seen for that measure since March 2002, when the stock market and economy was still suffering from the popping of the dot-com bubble.
The reason for the P/E spike is that expectations for the denominator have collapsed, while the numerator has recovered sharply.
S&P 500 company earnings for the first quarter this year are expected to be down about 14% from a year ago, the worst performance since the second quarter of 2009 in the wake of the financial crisis. Forecasts for the second quarter are not any better. Earnings projected to decline 41%, according to FactSet – the biggest drop since the first quarter of 2009.
Meanwhile, the S&P 500 index has rallied to sit just 14% below its February 19 record close of 3,386.15, while soaring 30% off the 3 1/2-year low of 2,237.40 hit on March 23. On March 23, the NTM P/E ratio was just 13.26, a seven-year low.