The Stock Market Is Pricing In The Wrong Type Of Economic Recovery

The pending economic recovery may not go as planned as millions of people have lost their jobs in recent weeks, and the impact of coronavirus continues to linger. The psychological toll the virus is likely to play cannot be understated and may play a significant effect on just how the economic recovery will take shape.

Many market participants are looking for a “V” or “U” shaped recovery, and I tend to think it will be something is between an “L” and “U,” which I am calling a “LU” shaped recovery, or tilted “L.” If that turns out to be the case, it means the recovery may be much slower than many are expecting, and the stock market may be in for a rude awakening, something we have been reviewing in my Marketplace service over the last few days.

Slow Return To Work

With non-essential workers now performing daily job duties at home, across much of the country, it may take some time for all of these people to return to their normal daily functions in an office setting. Additionally, the most logical path forward is for each state to try and separate people that may have already had the virus and were asymptotic from those that did not have the virus. People that have already had exposure and are no longer in harm’s way are likely to be the first people to return to work. It means that the economic restart may be uneven.

Another factor is the increasing likelihood that schools do not go back into session in 2020 across many of these states. For example, New Jersey just recently announced this on April 7. That likely means that New York is not too far behind. New York has already said they would be canceling their state testing at the end of the school year. Schools remaining closed until September could add another layer of uncertainty when it comes to the parents of young children, and how they return to work. If the schools remain closed, then it means that child care centers are likely to remain closed, and potentially even day camps during the summer. It implies many of these parents will likely need to continue to work remotely until the start of the school year again in September.

Social and Psychological Impact

At this point, it also seems unclear as to when restaurants, movie theaters, hotels, and non-essential stores will begin to reopen. The added question, when they do open, how fast the consumer will return to some of these non-essential businesses if the virus is still floating around in limited parts of the country. The psychology of being unsure, or not wanting to take a chance on getting the virus, may limit how fast this all rebounds.

From another point of view, in 2 weeks, there was nearly a decade worth of jobs lost. With uncertainty around what the demand will be from the consumer, how fast will employers be to rehire workers? We know from the previous recessions it can take a long time. For example, it took over six years for the number of total workers to return their peak pre-financial crisis levels. It took nearly four years to recover the jobs lost in the shallow recession of 2001. It seems too optimistic to think all of these people will return to work right away.

It means that hope for a V-shaped recovery is out, and the desire for a U-shaped recovery seems slim. The “LU” type recovery appears to be the most probably in my view, and it would undoubtedly be a more stable and even recovery. It’s something I do not think is priced into the stock market currently.

Phases

The stock market appears to be working in phases right now. The first phase was the initial shock that the coronavirus was real, and it was going to lead to many states closing up until the virus could get under control. Currently, the stock market is at the end of what I consider the second phase, where the impact of the virus is fading, and so equity prices are rising. However, in a matter of days, it will be entering the third phase, which will be the earnings season. Earnings estimates are likely still too high across the whole market place, and companies are pulling guidance even before the official earnings season starts. This is likely to be a trend that accelerates once earnings begin at a fast and furious pace. McDonald’s (NYSE:MCD) was the latest company to pull its guidance for 2020. The last and final phase, phase 4, will come as we start to get economic data sometime this summer that will show just how strong or weak the recovery is likely to be.

Risks

My thought process could be wrong if there is a proven vaccine that can come to the market soon and can be administered to people quickly. This would allow for schools to reopen and for the non-essential workers to return to their regular day jobs. It would also give people the confidence to once again begin traveling, going to a restaurant and shopping in malls. This type of scenario could result in a speedy recovery for the economy.

If a vaccine isn’t created, but there are treatment options that are proven safe and effective, people would at least have the confidence to return to their regular activities over time. It would more than likely result in that “U” shaped recovery many are hoping for.

For now, there is no option on the table, with the most likely being a slow return to work, at least over the next several months. With that being the most likely scenario, it would suggest that earnings estimates for the market will continue to drift lower, and the equity market will find itself in an overvalued state resulting in the S&P 500 declining from its current “phase 2” levels.

How far the equity market falls will mostly depend on how on just how deep the economic pullback is and how long it lasts. It could even mean taking out the previous March lows around 2,190 in the process.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.

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