We hope our readers are staying healthy and weathering the storm relatively well. We wanted to touch base with you since the news flow is swirling hourly and the market volatility is nothing short of breathtaking, even for the most grizzled investor. We are certainly not in the business of making short term predictions about when this all ends, but do want to offer some perspective about what has happened so far. Attached you will find a piece by Jim Paulson, a well- respected economist and strategist at Leuthold Group, an independent economics service we subscribe to. I think it is an excellent read and points out the market is responding to a unique knowledge vacuum surrounding the Coronas virus pandemic and to its eventual effect on the global economy.
Since the recent market peak on February 19, when the S&P 500 closed at 3,386, that index is down 30% give or take any given day or hour of trading. Some of us would say this revaluation was long overdue, but certainly the speed of the decline has been unsettling, even to those of us who thought the recent sprint to new highs was unjustified. A world- wide pandemic and subsequent recession fears will damage even a reasonably valued market let alone one that was, at a minimum, fully valued.
In the most basic terms, there are two variables that determine a stock index level or the price of an individual stock: earnings and the price investors are willing to pay for those earnings (price/earnings multiple). We know both the U.S. and global economies now face a sharp earnings decline. Depending upon which forecaster you consult, estimates for the S&P 500 2020 earnings per share (Strategas Securities LLC. March 20, 2020) have now fallen roughly 20% to reflect a global slowdown—from roughly $175 per share at the beginning of the year to about $140 per share currently. The price investors are willing to pay for those earnings has also declined from over 19 times at the peak to about 17 times the newly reduced S&P 500 earnings estimate. We think it is reasonable to say that the 30% decline in the S&P 500 discounts a significant portion of the expected fundamental damage from the epidemic. Revisions to the earnings outlook and the P/E investors assign to them are all but certain to lead to continued volatility for global capital markets.
Of course, unlike passive index investors, we are not buying “the market”, but instead are sifting through the damage that has been done to individual stocks we might want to own. As we assess our universe of what we believe to be high quality, financially strong, reasonably valued companies, we see the declines in many individual companies has been much worse than the 30% index drop. It is here that we are focusing to see where opportunities are emerging. We are not quite to the “kid in the candy store” stage yet, but suffice it to say, we see more attractive candidates now than we have in a long time.
You will soon hear a multitude of experts speculating whether the market has hit bottom and if the recovery in the markets and economy will be U, V or W shaped. We will leave that alphabet soup to others. Instead, we are doing our research and assessing stock valuations and fundamentals with the intention of taking advantage of opportunities as the market presents them to us and if they fit with the equity exposure we have discussed with each of our individual investors over the last several months. Please give us a call if you have specific concerns about your portfolio or would like to talk in more detail about unfolding events. In the meantime, as they used to say on Hill Street Blues “let’s be careful out there”.
This material and the accompanying article are intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors.
Radnor Capital Management, LLC is registered as an investment adviser with the Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training.