TL;DR — There’s a good chance we’ve already seen the bottom. Regardless, you should start investing now.
Before I dive into the unpopular opinion on why we’ve hit the bottom of the market in March, let’s first discuss the popular opinion that stocks will head much lower, as they did in 2008.
Bear Case — We’re In a Relief Rally, and The Market Will Head Lower, As It Did in 2008
It’s hard to turn on the TV without hearing about the heartbreaking news about the number of deaths and active cases developing in the US. This COVID-19 outbreak has not only caused significant loss of life but has also hampered the national economy, forcing businesses to close, leading to record unemployment numbers.
Bears will argue that this is only the beginning, as we are just beginning to see the impacts of COVID-19 on our national economy. In the months ahead, we should expect to see even more bankruptcies, more companies reporting poor earnings, and declines in consumer spending.
Whether it’s the talking heads on CNBC, Facebook users commenting on Marketwatch and WSJ articles, or Reddit users (r/wallstreetbets), the consensus appears to be that we’ll retest the lows of the market, and head significantly lower as the country heads towards recession.
Why Did The Market Tank 30%?
To understand the bull case of a market recovery from here on out, you have to believe two things: (a) the stock market hates uncertainty and (b) the stock market is forward-looking.
(a) The Stock Market Hates Uncertainty
It’s important to understand that the stock market didn’t drop just because of expectations of COVID-19 deaths and bad earnings. While there were numerous expected drivers of the stock market decline, there were several surprises too.
- US consumers stay inside, and as a result, reduce spending
- Companies will report much lower Q1 and Q2 results
- Demand for oil will decline as Americans stay inside
- Companies that live quarter to quarter will have cash flow problems and will go bankrupt
- The US government will respond with a stimulus package sometime in the next 3 months
- The virus was worse than expected (largely because the US ignored early warnings). As a result, the US enacted shelter-in-place orders at the state level, forcing businesses to fire employees given the extended weeks/months of closure
- Saudia Arabia and Russia began a conflict over oil, driving down the price significantly
- The credit market underwent extreme stress
- Liquidity crisis
During the relief rally, we have gained clarity (but not full-on certainty) behind a lot of the surprises. We know that the first wave of the virus will eventually hit an apex, and life will return to normal. We have countries that are ahead of us on this virus trajectory (e.g. China, Italy) that can prove to be valuable case studies for when shelter-in-place will be lifted in the US (May-June?). Americans have also begun having conversations about returning to work, even if it may be different for the first couple of months.
The Federal Reserve has also pumped in unprecedented liquidity into this market and has purchased not only investment-grade bonds but junk corporate bonds as well.
There’s a lot less uncertainty than there was a month ago. In my opinion, the surprise events that remain are the potential for a second wave of COVID-19 and to some extent, the outcome of the oil negotiations (though that will no longer be totally out of left-field). The market is expecting bankruptcies and is expecting earnings to be bad. We might be seeing bigger misses on earnings than expected, but at least we’ve begun to calibrate our expectations.
(b) The Stock Market is Forward Looking
The market is forward-looking, and if you ask most people, they think the market will return back to normal in 2021. If people think the market will be higher in 2021, why not invest now? It seems like retail investors are waiting for a better buying opportunity, and believe the market will continue going down. But if most retail investors think that’s going to happen, will it?
It’s important to recognize that the stock market is not the economy. The stock market is a leading indicator, while an economic recession is a lagging indicator. With unemployment likely to hit 12%+ (maybe even 20% or more) and consumer spending in the toilet in the near-term, it’s very likely that our country is headed for a recession. However, looking at historical data, the stock market has, for the most part, recovered before the real GDP of the economy recovered.
In 1933, the S&P500 climbed 50% while real GDP declined 1%.
In 2009, the S&P500 climbed 26% while real GDP stayed flat.
There’s a lot more certainty than a month ago, and the market believes that we’ll recover eventually. But more importantly….
This Time, We Have the Blueprint
“There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch.
But in the long-run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the dog watchers, big and small, seem to have their eye on the dog, not the owner”
Using the metaphor above, the owner is the US government and the Federal Reserve. They are to a large extent, guiding the US stock market, and deserve our undivided attention. As a result, it’s important to compare and contrast what the dog owner was doing in 2008 vs. what they are doing now.
In 2008, we ran into a failure of large institutions. This created a crisis of confidence in the system. Would the banks fail? What would happen to all my money that’s in the banks? The government was uncertain about how to respond. There wasn’t a clear precedent for a stimulus package, and it was unclear what they should do to assist the financial system. After months of gridlock, the US government passed TARP, providing $700 billion to aid the financial system.
This time around the government had a blueprint of how to respond. Congress was quick to pass a $2 trillion stimulus package to provide much-needed relief to everyday Americans (as compared to TARP, which helped corporations). On top of that, the Federal Reserve has pumped an unprecedented amount of money ($6 trillion+) into the US economy, providing much-needed liquidity and relief. It wouldn’t surprise me if the government was quick to pass a second stimulus package to further prop up the market.
I think it’s a bit misleading to compare the current situation with 2008. This time (from a financial perspective, not a health perspective), our government acted much more quickly and has put significantly more firepower into the market than before.
It’s also important to remember that people were really scared about the economy back in 2008. People didn’t know how bad it was going to get. There was a lot of uncertainty, and it didn’t help that the subprime mortgage crisis was so difficult to understand. This time around, people can easily point to 2008 because they’ve lived through it. People know what to expect, and the government has reacted accordingly.
This decline was fast, but I believe the recovery will be fast as well. The dot-com crash of 2000 took almost 7 years to recover. The Great Recession of 2008 took almost 5.5 years. Rallies rarely go in a straight line, and given the tug of war between bulls and bears, there’s a chance that this one won’t go in a straight line either. However, I think that expecting a return to normal in 2021–2022 (a faster recovery than 2000 and 2008) is a likely possibility.
You Get Paid to Be a Contrarian
The risk/reward payout for a contrarian mindset has arguably, never been larger. We are currently living in an investment environment where internet bloggers and CNBC talking heads are talking about “retesting the lows” or “it’s going to get worse before it gets better”, parroting talking points with no actual idea of what they’re talking about.
We are headed for a recession. The question is — are we headed for a bear market with a 50%+ decline, or is 30% the lowest we’re going to get?
The markets may be considerably lower sometime in the coming months, but for many stocks, we’re already looking at prices that are already 20–30% off their all-time highs. We should buy when we find good value, and for many companies, they’re sitting at good value right now.
Most people are loss-averse and are afraid of entering the market now for the risk of losing money. My argument is that the risk of missing an opportunity here is greater. The COVID-19 crisis has created many market opportunities. This may not be the best time to invest, but it should be a good time to invest, which is fine, because it may be impossible to find the best time.
All great investments begin in discomfort. The best time to buy generally comes when nobody else will.
The goal should be to make a large number of good buys, not just a few perfect ones.
Luckily, the market decline has affected all stocks, meaning there is a real opportunity to drive alpha by picking the right ones.
Here are the long positions that I’ve been entering and will continue to buy over the coming months.
- Cruise Lines (Royal Caribbean, Carnival, Norwegian Cruise Lines) — The risk-reward payout here is huge if you’re right about them returning to normal (+300%). According to CruiseCompete.com, bookings for 2021 are up 40% compared to 2019. People who have taken cruises in the past want to take advantage of low prices on cruises in the future. There’s a chance that cruises go under, but if you invest in all 3 of these, you can still make money if two go bankrupt and one of them survives (due to the huge payout on reversion to 2019 levels). The biggest risk here is the (potential) second wave of COVID-19 that will elongate liquidity needs for these companies.
- Major Hotel Chains (Marriott, Hilton) — Like cruise lines, the risk-reward payout here is large. Once the first wave of COVID-19 passes in the United States, business travel will revert to normal, and eventually, personal travel will as well.
- Cloud Computing Companies (Amazon, Microsoft) — Both Amazon and Microsoft should benefit from huge tailwinds in cloud computing. Microsoft has also reported capacity issues during the current month of remote work, which may indicate that they’re getting more demand than before. If more companies shift to remote work, Amazon and Microsoft could be big beneficiaries here. Additionally, Microsoft Teams (their video conferencing / collaboration platform) will likely benefit a lot from tailwinds in remote work.
- Facebook —Compared to other technology companies, Facebook is trading at a more significant discount relative to its peers. They are likely to lose a lot of ad revenue this year, which is what is probably driving the decline in their stock price. However, the company owns WhatsApp and Instagram, which are both experiencing exploding user growth. Oculus, VR, and Facebook gaming could also provide some good upside here, but I wouldn’t count on it.
- Behavioral-Shift, Technology Companies — Due to the COVID-19 crisis, some technologies have been pushed further along the S-curve of adoption. These include eCommerce companies (Wayfair, Amazon, Sea Limited), online dating companies (Match Group), gaming companies (Sea Limited), work communication companies (Slack) and at-home entertainment companies (Netflix)
Other ideas I’ve been exploring include:
- Airlines (United, Delta)
- Online Travel Agencies (Booking.com, Expedia)
- Other COVID-19 Impacted Companies (LiveNation)