We Won’t See It in the Economic Data

We are often asked how we are analyzing markets in this crisis thrust upon us by COVID-19.  What are the economic indicators that we are closely watching?  What is it in the data that will provide us the confidence that things have turned?  The inevitable truth is that the economic data is not going to be any help in analyzing the situation.  It is going to be a mess for a while.  The numbers are going to be horrible.  Some of the worst we have ever seen.  It will be hard to take any conviction from the data – in fact it will be quite the opposite.

Calling market tops and bottoms has been, and always will be, a fool’s errand.  Calling the bottom this time around is no different.  Logically you would think the bottom will come with an easing of the public policy response to the virus – travel restrictions lightened, social distancing relaxed, and non-essential services reopened.  If this were true, the bottom would be seen in the flattening of virus infections or (hopefully) in scientific discovery.  The market will, however, most likely bottom in anticipation of either of these events occurring.  Thus, making it impossible to call.

We keep coming back to two very important points.  First, the liquidity being provided by the central banks and fiscal spending by governments globally is absolutely mind blowing.  If we were to shout this from the rooftops as loud as we could, we wouldn’t be stressing this point enough.  Second, equities are the longest duration assets out there.  They are perpetual earning machines.  The next two or three quarters of earnings really do not matter significantly to overall equity values.  For single stocks with weak balance sheets the next couple of quarters might be critical but this is not the case for equities as an asset class.  (As an aside – the current crisis underscores the benefit of investing in asset classes over single stocks.  There will be companies that fail.  There will be companies that survive and some that really thrive.  You can take confidence in that fact that you own them all.)  We are seeing unprecedented value with historic equity yield premiums over the risk-free rate.  These two points together offer an explosive upside to equities.  And the market may just figure this out before there is a noticeable change in the virus numbers or in the science.

When upside revaluation happens, as we expect, it will be just as violent as the correction we have just experienced.  It may possibly be even more dramatic.  You will want to be positioned before it happens.  If you are not, you will miss it.  For this reason, we will be rebalancing in short order.  We have been waiting for orderly markets to do so.  It is conceivable that equity markets will fall further.  It is most certainly the case that they will be volatile in the days ahead.  However, we must accept these likelihoods to be positioned for the coming opportunity.   Equities, today, offer significant value over fixed income.