In my previous posts (available here), I highlighted how COVID-19 could create a generational buying opportunity for investors with capital, courage, and conviction. As a rule, you do not want to bet against human ingenuity; our species is quite good at solving big problems when we must. Today we examine some of the signposts were watching to identify a market bottom and how we are preparing to deploy capital.

 

For context, the chart below illustrates the unprecedented pace of decline we’ve witnessed this year.

 

 

Fundamentals

As a result of this selloff, the valuation of the S&P500 has compressed significantly. While the forward earnings estimates will continue to be revised, the entry point certainly looks more attractive than it did earlier this year.
 

Other signposts that I was trained to look for while working as an institutional equity sale person include:

• The Fed cutting interest rates by more than 50bps – they’ve cut 150bps so far;
• Banks significantly tighten lending standards – this hasn't occurred yet;
• S&P500 company earnings are revised down twice as often as they are revised up – this just occurred; and
• Cash balances in Bank of America’s Global Fund Manager survey are above 5.0% - this level was reached earlier this month.
   

Sentiment

 

Source: CNN Business

The challenge, in bear markets, is that cheap valuations, growing cash balances and underweight positioning are generally not catalysts for sustained reversals.  We need to see sentiment improve and a significant improvement in sentiment seems unlikely until we see the pace of infection growth in the US and Europe start to slow. Unfortunately, a slow down in the pace of infect still appears a few weeks off.

 

Other catalysts that could cause a significant positive reversal in sentiment would the discovery of effective anti-viral drugs or the announcement of a vaccine. Catalysts that would put incremental pressure on sentiment would be outbreaks after lockdowns are lifted, a re-emergence of the virus in the fall and/or cases of reinfection.

 

Thinking Long-Term 

 

While the near-term disruption created by our attempts to limit the spread of the coronavirus will likely result in one of the deepest and briefest slowdowns in modern history.  Inventories are being depleted and spending a few weeks at home will create significant demand for a multitude of goods and services once we return to business as usual. From a fundamental perspective, the long-term impact of this pandemic likely means modestly lower corporate profitability from higher taxes (to pay for fiscal stimulus), greater supply chain diversification, higher inventory levels and a greater focus on business continuity.

How to Take Advantage of this Market

 

1. Formulate a plan for putting money to work. Market timing is difficult and putting consistent amounts of money to work at regular intervals means you will buy more securities when markets are inexpensive and fewer when markets are expensive. If you have incremental capital available today, decide what you need to see to start and to continue deploying capital, particularly into industries that have been hardest hit by this pandemic.
2. Build a shopping list. Many high-quality companies are now trading at large discounts to their historical valuations, thanks in-part to investors selling indexed securities.
3. Examine, rebalance and high-grade your portfolio. If you have positions that you would not purchase today, on an after-tax basis, you should consider rotating higher-quality companies that you are comfortable owning through market cycles. Think of the securities in your portfolio as players on a professional sports team; they need to try out and prove they deserve to play every day!
4. Take notes. Investors can be their own worst enemies so take notes and what you are planning to do, when you plan on acting, and what you might have done differently. A calendar is completely underappreciated investment tool.
5. Most importantly, remain intellectually honest. This market is moving quickly against a very dynamic global landscape; it is important to revisit and revise your views as new information becomes available.

Please reach out to have a more involved discussion.

Stay safe.
 

Delli (delli@cibc.com) 

 

I’m not epidemiologist, and I’m not endorsing nor do I share all the opinions of the authors but here are some of the more interesting articles I’ve read on COVID-19:

• Coronavirus: Why You Must Act Now
• Coronavirus: The Hammer and the Dance
• Why the Coronavirus Has Been So Successful
• How Italy became the ground zero of Europe’s coronavirus crisis

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