Back in June, in our post, This Market is Bananas! B-A-N-A-N-A-S! A Bull Market Thesis, we made several arguments to support equity markets moving higher. The blog aimed to provide a bullish opinion to contrast the dire predictions from many prominent money managers. Since the chart below, which overlays S&P500 performance in 2009 and 2020, has been most relevant.

 

 

Today, we will examine another bullish argument for equities from Howard Marks, recent developments in COVID-19 testing, and the risks posed by the 2020 US Presidential election.

 

A Bullish Argument for Equities from Howard Marks

 

In a recent memo, Howard Marks eloquently put equity market valuation in context. I believe Howard is one of the most insightful and articulate macro minds on the planet. Here are Howard's thoughts:

 

The first is that many investors have underestimated the impact of low rates on valuations. In short, what should the stock market yield? Not its dividend yield, but its earnings yield: the ratio of earnings to price (that is, p/e inverted). Simplistically, when Treasurys yield less than 1% and you add in the traditional equity premium, perhaps the earnings yield should be 4%. That yield of 4/100 suggests a p/e ratio (the inverse) of 100/4, or 25. Thus the S&P 500 shouldn’t trade at its traditional 16 times earnings, but roughly 50% higher.

 

Even that, it’s said, understates the case, because it ignores the fact that companies’ earnings grow, while bond interest doesn’t. Thus the demanded return on stocks shouldn’t be (bond yield + equity premium) as suggested above, but rather (bond yield + equity premium - growth). If the earnings on the S&P 500 will grow to eternity at 2% per year, for example, the right earnings yield isn’t 4%, but 2% (for a p/e ratio of 50). And, mathematically, for a company whose growth rate exceeds the sum of the bond yield and the equity premium, the right p/e ratio is infinity. On that basis, stocks may have a long way to go.

 

Howard Marks, Time for Thinking (August 5^th, 2020)

 

A Bullish Development in COVID-19 Testing

Another bullish development that I believe could have a more profound impact than a vaccine is the COVID-19 test from Abbott Labs that was approved for use in the US earlier this month. The test, called BinaxNOW, costs $5, produces results in 15-minutes, and can be self-administered. Abbot plans to be producing 50 million tests per month by October. While many people may be nervous about taking a fast-tracked vaccine, I think few would object to taking a self-administered test that costs less than a Starbuck latte before heading to work or going out in public.  This type of test could be critical to the next phase of economic acceleration.

 

Who won? The next significant risk on the horizon

 

US Citizens will elect a President for the 59^th time on November 3^rd, 2020.  I believe more significant risk than who wins the next US election, is how long it takes to determine who has won the election. Markets hate uncertainty and the outcome of the US election and the partisan rhetoric while votes are counted, could be a significant risk-off event.  The article, The 10 Scariest Election Scenarios does an excellent job of highlighting potential risk around the US Election. (Note: I’d suggest reading the article from the bottom since potential risk are presented from least to most likely).

 

How should an investor approach this market?

 

At the risk of sounding like a broken record, I continue to recommend investors pursue a barbell strategy where high-quality companies exposed to secular themes provide exposure to equity markets, while fixed income, cash, and alternative investments are used to reduce volatility and provide ballast for portfolios.

 

Please contact me for a more detailed discussion.

 

Delli (delli@cibc.com)

 

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