By this time, 2019 Novel Coronavirus (COVID-19) 24/7 broadcasts, plus the internet, should enable investors to be on top of the pandemic’s macro and personal effects. All our personal expertise now covers such familiar terms as social distancing and community spread. Rather than dwelling on the well-covered aspects of COVID-19, this commentary will provide some perspective on one key to speeding the economic recovery. Then it will examine the perspective for potential recovery of the S&P 500 Index.
The Federal Reserve and Government will flow at least $6 trillion into the economy to stabilize it and stimulate recovery. With consumer spending representing close to 70% of gross-domestic-product (GDP), the speed of any potential economic recovery will importantly depend on how long the virus will affect consumer “psyche” and, therefore, their willingness to spend.
Obviously, the key to returning to some sense of normalcy requires taming COVID-19. Several drug programs in the development stage could possibly provide a solution this year — hopefully sooner than later. Otherwise, a vaccine will not likely show up for about a year or more. How stretched out the economic recovery ultimately takes, in our view, partially depends on medical solutions for the virus that will relieve consumer concerns.
Let’s look out over the next three years. Before the COVID-19 pandemic, the economy showed continued strength, admittedly at a slower growth pace. In the second quarter of this year, however, the economy will likely move through the valley of the economic decline. Most economists seem to be playing “Can You Top This?” on guessing the depth of the economic drop in the second quarter. However, following the shutdown, the economy will likely regroup and bounce back. Then over the next three years, economic growth will likely recover to its sustainable annual growth rate of about 2+%. Figure 1 shows a longer-term economic forecast that represents this outlook of many economists at present.
Using that economic perspective, we then turned to projecting what level the S&P 500 Index might reach by the end of 2023. In doing this, we looked back at the financial markets coming out of the Great Financial Crisis. After considering different possibilities, we concluded that using 2009 provided a reasonable base to build the analysis. Investors mark March 2009 as the beginning of the bull market. Then we used 2013 for a longer-term perspective. With those bookends, we used S&P 500 Index prices as of March 1, 2009 and July 1, 2013. For S&P 500 earnings per share (EPS), we used full-year earnings per share for 2009 and 2013 (See Figure 2).
Bringing that perspective to the present, S&P 500 earnings per share at the end of last year reached nearly $163 per share. Using a more conservative annual earnings per share growth rate than 2009-2013 experienced, S&P 500 earnings could reach $205 per share in 2023, using a projection of an 8% annual growth rate.
Recent price/earnings (PE) multiples show higher levels than a decade ago (see Figure 3). This difference may reflect, in part, the sharp decline in interest rates over that period. Using a lower price/earnings valuation than in the recent past of 17x but higher than earlier in the decade brings you to an S&P 500 Index value of 3485 for 2023. That value would represent about a 42% annual return over the S&P 500 Index close of 2447 as of March 24, 2020. Our rough analysis suggests a reasonable leeway for long-term return prospects in selected equities from this stock market level even if the market moves lower.
COVID-19 shocked the world. Investors, along with their fellow citizens, lacked any basis to determine the outcome from this pandemic. This virus will likely come under control in the not too distant future. With that, the economy will rebound, admittedly at some uncertain speed, but recover it will.
In the past, we recommended an asset mix of 40% equities, 35% alternatives, and 25% fixed income. Despite the economic and financial hurricane, we remain very comfortable with that asset mix recommendation. Reaching that recommended equity asset mix after the recent sharp market slide ultimately leads to rebuilding equity positions of high-quality companies with strong balance sheets at what will likely prove attractive prices. How fast each investor rebuilds depends on their own comfort to do so. In the case of fixed income, we recommended short-term credits to preserve capital, and that continues to be our recommendation.
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