As we move from stage one of the pandemic response—a blunt force shelter-in-place mandate across major US geographies—to stage two of increased response precision, it's critical to assess how the magnitude of the financial response relates to the level of economic impairment. Both sides involve moving targets, but we have enough evidence to increase our degrees of confidence in drawing market conclusions. That said, there's no way to candy-coat it—we missed the call of a precipitous drop in equity market pricing. Now, the key is shrugging off analysis paralysis as we enter the eye of the COVID-19 storm. The particular challenge to the Level 5 hurricane that is this pandemic: its market impact arrived 4x faster than any prior recession since the 1960s (as we outlined here last week). As every prior downturn has taught us, we need to move past the headlines and study the second and third derivatives. In our constant exercise of gathering and assessing evidence, it's increasingly apparent that the main drivers of economic output are not permanently impaired. Undoubtedly, they will show deterioration in the coming weeks and quarters, but it's imperative to consider these scenarios relative to what the market has reflected in its (34%) price correction.
$6 Trillion in Context: $12 Trillion of Market Cap
In a little over one month, the US equity market experienced a $12 trillion erosion in market cap, as evidenced by the Wilshire 5000 Total Market Index whittling down to $22.5 trillion in total publicly-listed market cap as of March 23rd. As Congress puts the finishing touches on its stimulus efforts and the Federal Reserve opens relief valves, we're looking at roughly $6 trillion of total stimulus being deployed to repair the $12 trillion sinkhole. Since equity market cap reflects the pricing of economic output, this ratio doesn’t need to achieve parity in order to be effective.
Also, a silver lining to having a separate multi-trillion-dollar crisis in the rearview mirror is the powerful lesson it provides of how equity markets react to the staging of massive financial weaponry. S&P 500 companies did not stem earnings declines, year-over-year wise, until the fourth quarter of 2009. However, the S&P 500 Index marked its bottom nine months prior in March 2009, when the main elements to our response were being assembled but nowhere near fully deployed. Many other financial metrics also continued to worsen well past March 2009 (scenarios that we revisited recently here). We’re all well aware that equity markets attempt to reflect future cash flow outcomes. The ongoing calculation behind this tends to work well over longer periods. When trillion-dollar-sized wrenches get thrown into the economic machine, the likelihood that the pricing calculation overshot its mark increases dramatically.
$6 Trillion in Context: $815 Billion in GDP
Another way of framing the analysis is by looking at the output impairment to GDP. If Goldman Sachs' recent outlook is close to reality—a 24% QoQ decline in 2Q2020 GDP that results in a full-year GDP impairment of 3.8%—this translates into $815 billion of GDP lost in the year. Unlike market cap’s existence as a multiple to economic output, GDP impairment is arguably a more direct target for the $6 trillion of stimulus. Though the peak-to-trough market crash during the financial crisis was sharper—(57%) versus (34%) thus far—the economic impairment across 2009 was only $263 billion, a 2.5% erosion YoY in real terms.
Should 2020 GDP shape up to be $20.6 trillion in the Goldman scenario, this would place the market right below a 1:1 ratio in the "Buffett Indicator," i.e. market cap to GDP. This in turn places us well below "overvalued" territory of this commonly cited proxy.
Targeting Consumers’ Wallets, Not Bank Equity
Today's stimulus efforts also are arguably directed towards stimulating consumer spending, whereas our last efforts were squarely focused on stemming financial contagion and shoring up balance sheets. Trillions flooded to the equity side of bank balance sheets and sat there dormant. Banks were incredibly reluctant to lend for the next five years, much to the chagrin of the political complexes that moved mountains to implement the capital injections. Today's stimulus is largely an effort to provide bridge facilities for coming out of shelter-in-place periods. There will be landmines among financial institution balance sheets as non-performing loans and unemployment move higher. However, banks as a whole are on much better footing to absorb this round of losses, and the consumer is on an entirely different plane than it was 11 years ago.
March-to-Date Business Proxies
As we delve into bottom-up proxies of how businesses are faring during the first few weeks of US virus-mitigation efforts, we see evidence of equity prices looking past March and June quarter results. In fact, some business models are better poised to capitalize on massive demand shifts to online order management and delivery fulfillment. Square, Inc. [SQ] is a good example of one. Its business update call on Tuesday highlighted a 25% year-over-year decline in gross payment volume ("GPV") across its network for the prior 10-day period. Meanwhile, its merchant customers' efforts to enable curbside pick-up and seller-powered delivery caused a 3x lift to daily GPV in its Square Online Stores offering. Additionally, its Cash App segment experienced a record number of new activations last week due to increased spending/sending/investing initiatives.
Similar themes were reinforced from NIKE, Inc. [NKE] and Zillow Group, Inc.'s [Z] respective updates earlier this week. All three stocks have experienced sharp positive price reactions following their releases despite precipitous drops in March demand and articulation of reduced visibility for the remaining year. We will delve into these themes in greater detail next month in our Growth Equity strategy's quarterly update, but the bottom-up analyses are starting to provide proxies of how equity pricing is absorbing the adverse fundamental impacts.
Eye of the Storm?
The elements of the equity market's bottom formation occur in the eye of the storm. This is where the collective focus shifts from the trauma of what's already hit towards what's coming behind the eyewall. As we look at the outer rain-bands to come, we know many proxies of economic health will show deterioration, just as they did in the prior recession. The tools for weathering this storm are within reach today: increasing testing kits, accelerating their results delivery, enabling in-home testing, becoming more precise with targeted quarantines, and developing therapeutics and vaccinations. The best scientific minds have the most advanced tools humanity has ever had in combating a pandemic: genome sequencing, super-computing capabilities of machine learning, and massive scientific global collaboration. This signals that odds are stacking up that we're much closer to the storm's eye, or possibly smack-dab in its center. These are precisely the conditions that translate into attractive “up/down” ratios, ones where the absolute value of the upside opportunity far surpasses what’s left to endure on the downside.