This Month’s Newsletter

Does Anything About This Feel Normal To You? Join our Monthly Newsletter June 2020

Mark R. Hoffman

CEO, Principal

On Friday morning (6/5/20), I was putting the finishing touches on this monthly article when the jobs report hit. Consensus estimates were that the unemployment rate would close in on an astounding 20% with another large wave of layoffs. Instead, the US added 2.5 million jobs and the official unemployment rate stood at 13.3%. What? The equity markets raced to the upside once again and I hit the delete button on my now obsolete analysis of where we stand.

After the fastest drop in stock market history due to the COVID outbreak and subsequent economic shutdown, we are now within spitting distance of flat for the year. Market cycles are normal. Corrections are normal (since 1980, there have been thirty-seven 10%+ corrections in the stock market). But does anything about this feel normal to you? We were told in late March that this one was different. But since then, the stock markets have told us that maybe it’s not.

Before everyone declares that the bull market is back and that we should be long everything, can we at a minimum acknowledge that the stock market and company profits are saying two different things? At the end of May, here is where that stood:

The chart above represents the change in the S&P earnings per share vs. the change in the S&P price. Talk about a disconnect. Additionally, at the end of May, the forward 12-month P/E multiple stood at 21.5. The five-year average is 16.8 and the ten-year average is 15.1. The last time the P/E was over 21 was in January of 2002. If the stock market is supposed to be a reflection of the underlying earnings of the companies it represents, something is off.

So, maybe the market is saying near-term earnings don’t matter. The only thing that matters is reopening the economy. Happily, the economy is reopening and we should applaud that. But there are broad swaths of the economy that have such a long way to go it’s hard to think that things are back to normal. CNBC publishes a series of charts (“Five charts that track the U.S. economy amid reopening progress”) that measures how significant the rebound has been. Here are three of the five. Restaurant bookings are down ~75% vs. last year. Hotel occupancy is below 40% (the ten-year average in the month of June is in the high 60’s). And U.S. air travel is still down 80%+ year-over-year.

At times like this, I ask “what would I have to believe…?” What would I have to believe to think that we are in a normal economic cycle and that we can pick right back up where we left off before COVID hit? I think I’d have to believe some combination of the following:

That the worst of the actual COVID virus is behind us, that someone creates an effective vaccine – and that everyone takes it
That our economy reopens in full and does not shut back down
That everyone that was laid off goes back to work at full capacity
That the $2.4 trillion (and climbing) the federal government has spent to fight COVID can be easily absorbed without compromising our ability to grow
That the debt that companies have taken on to get through this crisis can be easily paid down
Etc., etc., etc.

I don’t think any of those are a given. Not one. I hope I’m wrong, but this doesn’t feel normal to me.

Mark is a co-founder of Lanier Asset Management and serves as its Chief Executive Officer. Prior to founding Lanier, he was a partner at The Boston Consulting Group. Mark is an honors graduate of The University of North Carolina at Chapel Hill with a BA in Economics, and holds an MBA from The Harvard Business School.