The Leap From The Lion's Head


If you’re of a certain age, and even if you’re not, you’re likely familiar with the climactic scene from Indiana Jones and The Last Crusade in which Indy has to take a literal leap of faith across a deep chasm in order to claim the Holy Grail and save his father’s life. “Only in the leap from the lion’s head will he prove his worth” reads the final of the three mystic challenges that serve to instruct Grail-seekers along their usually deadly path.

I can’t help but think about this scene when I think about the markets this summer. I know that being invested is what I want, and I know that in the long run, being invested is critical to wealth preservation and development. But, boy, that sure seems like a long way down!

As investors and capitalists, our faith is being tested by this powerful rally amid generationally unprecedented problems in the economy and in society. And yet, these significant problems seem to be already heavily discounted by the markets. Lately, it seems that the worse the news, the more powerful the rally.

Is this due to the market’s complete faith in the Fed and in Congress, which have already committed to backstopping the economy to the tune of up to $6 trillion? Maybe the market has already sniffed out something about COVID-19 that the general public has yet to realize. Reports circulating that the mortality rates are lower than first thought seem to be gaining credence. Or maybe the market just has one big case of FOMO.

Whatever the case, the market’s move up has been swift and powerful. Yesterday, the S&P 500 erased its year-to-date losses, completing a climb of 44 percent off the lows. Both the S&P 500 and the Dow Jones Industrial Average were up 25 percent for the quarter at yesterday’s close. The tech-heavy NASDAQ is now up 11 percent on the year, and 30 percent this quarter. Small caps have fared even better, with the Russell 2000 up more than 31 percent for the quarter, now down just 9 percent on the year.

Volatility as measured by the VIX is still extremely elevated at 27, suggesting that there is still a historically high level of fear in the market, which I believe is a bullish indicator.

Yet, all of this is taking place amid a massive collapse in economic activity. Perhaps the bottom line is that expectations were so dire that a whiff of good news can ignite a powerful rally. The market got just that on Friday, when unemployment numbers came in substantially better than expected. While the consensus view was for an additional 7.725 million in job losses, payrolls actually increased by 2.5 million, and the unemployment rate, instead of climbing to 19.8 percent as expected, fell to 13.3 percent. Now there were a few puts and takes that may have made the jobs number look a little better than normal, but it was undeniably a favorable report. Animal spirits surrounding the reopening of the economy seem to be carrying the day.

So, great. Investors are feeling better, feeling more confident in putting capital at risk. Now what? It’s almost impossible to make the argument that the market is inexpensive, at least using the normal yardsticks. Corporate earnings do matter in the long run and even in the not-so-long run, and they’re just not there right now. On a forward PE basis, the S&P 500 is now trading at almost 23 times earnings—that’s more than 2 standard deviations above the 25-year average of about 16.4x. Yes, I get it—earnings this year are depressed by a largely exogenous shock. But still, come on. These are now dotcom levels. Yes, perhaps an adjusted earnings measure like Shiller’s PE, which uses a 10-year inflation-adjusted earnings number, is a better measure, and the results don’t look quite so extreme, (only overvalued by half a standard deviation), but I think you get the point. This might not be a bad time to buy stocks, almost certainly not for the faithful long-term investor, but March was better.

Generally, business executives with whom I speak are not yet reporting meaningful improvements in corporate performance since April. Conditions are not worsening, but no one is reporting anything to me that suggests a “V-shaped recovery” is a sure bet. Second quarter earnings reports and full year guidance, to the extent it exists, appear to be the next critical challenge.

Long-term investors should not lose faith, but remember… “In the Latin alphabet, Jehovah begins with an I!”

Any opinions are those of Burke Koonce and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Burke Koonce is a financial advisor at Raymond James & Associates, Inc., member New York Stock Exchange, member SIPC.



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