Is It Safe To Jump Back In?

According to a story I read recently, Bank of America has announced the lows are in for stock prices. This means the low during this bear market is about -35% from the peak. As of now, we are down about -23%.

But are things really over? Can we confidently start buying the market again (though I’ve been buying some individual stocks)? Personally, I think Bank of America is a little early on their announcement. Some things to consider:

  • We’ve lost 10M jobs in 2 weeks and we’ve only just started to see the carnage. The Federal Reserve projections show the possibility of about 30% unemployment. If consumers are 70% of our GDP then that doesn’t bode well for the near-term outlook.
  • We’ve not seen the virus peak anywhere in the US. Hard to call a market bottom until this happens.
  • Corporate share buybacks will be greatly reduced going forward. Many have already suspended buybacks. Buybacks have been a large source of equity demand and their reduction will likely mean higher volatility and lower stock prices.
  • Company earnings and, more importantly, forecasts are coming soon. From what we know now, few will have the guts to create a forecast in this crazy environment.
  • We don’t know yet if the Federal Reserve and Congress stimulus measures are enough to keep the economy going … it’s just too soon.

Their are so many data points that just make it unclear right now. I’m not sure why Bank of America felt the need to make their prediction at this point in our downturn. There are still many issues that just aren’t clear at this time and it would have been prudent for them to wait.

Are We Really Undervalued?

A good way to understand if the market is undervalued is the S&P 500 PE ratio. This ratio is historically about 15 and more recently 23 the past 5 years. Today, we are around 20. That’s right, even with the market downturn we are still at 20.

Source: Multpl.com

But let’s pretend that earnings over the next 12 months take a 25% haircut. Let’s do the math.

  • Earnings of 133.89 x 75% = 100.42 in earnings
  • S&P 500 price as of 4/7/20 = 2,663
  • 2,663 / 100.42 = S&P 500 PE ratio of 26.5

So even with a 25% earnings drop in the next 12 months, our forward PE ratio is still 26.5. That’s too high in a great environment and horrible for one we are in now.

Source: Multpl.com

This is just one of many reasons I think we are still not undervalued. I don’t even think we are fairly valued. In my opinion and with all the issue at hand, we are likely to revisit the lows (or worse) in the next few months as the economic impact unfolds.

For the record, I think we have more than a 25% reduction in earnings. Just look at what happened in 2008-09 and I don’t see why that won’t happen here too.

So What Now?

I can only tell you what I’m doing with my 401(k) and taxable stock portfolio. Let’s start with the 401(k). Since I’ve been moving cash to equities on the way down, this recent 20%+ market rally has brought me close to breakeven.

I’m not a fan of trading in my 401(k) but I’ve bulked up on cash now for 2 main reasons: (1) sequence of return risk since I’m 5 years away from retirement and (2) I think we’ll revisit at least the lows of the market.

If the market doesn’t revisit it’s lows then I’ll have to figure out some logical way of getting back into the market. I don’t see this happening but it’s always possible. But if I’m right and the market goes back down over the next few months, I’ll be sitting on about $300,000 in 401(k) cash ready to transition back into equities.

This is my way of minimizing my risk since I’m only 5 years away from retirement. My more active style this past few weeks has allowed me to avoid a majority of the downturn and I just might be able to ride it up soon.

Of course, I’m leaving my taxable stock portfolio untouched and I’ll keep buying if individual stock opportunities arise. That portfolio is expected to produce over $5,700 in dividends during the next 12 months. Those dividends are being reinvested to buy more shares.

Conclusion

History shows that bear markets often feature aggressive rallies like those we seen in the last 2 weeks, only for stocks to resume their decline. We just have way too much uncertainty in the markets to think we won’t have more significant down weeks or months.

And to me it’s all about jobs right now. Consumers are losing jobs at record pace. The Federal Reserve is predicting the possibility of extreme unemployment rates. Given that we’ve already lost 10 million jobs in the last two weeks, I think we are just starting to see the damage.

For this reason, we simply took the average of those two numbers as a point estimate for the total number of workers who will be laid off during the second quarter. This resulted in 47.05 million people being laid off during this period. Given the assumption of a constant labor force, this resulted in an unemployment rate of 32.1%.

St. Louis Fed

Bottom line: If you are sitting on a bunch of cash in a taxable account, it’s ok to buy individual stocks in the right sectors (i.e. consumer staples and healthcare). But if you have a bunch of cash sitting in your 401(k), then it might be too early to get aggressive. Be patient and let’s see how some things unfold with jobs, earnings, the virus, and many other factors.

Stay safe and thanks for reading!

Mr. TLR