Superbug, Superbull

As the Mayo Clinic defines them, “Superbugs” are strains of bacteria that are “resistant to the majority of antibiotics commonly used today”.

“Antibiotic resistance is a naturally occurring phenomenon that can be slowed, but not stopped”, Dr. James M. Steckelberg explains. “Over time, bacteria adapt to the drugs that are designed to kill them and change to ensure their survival”.

This bull market – the longest in history – has many of the characteristics associated with a “Superbug”. Over time, it’s adapted to things that are designed to kill it. It’s changed to ensure its survival.

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Ironically, the most recent threat to the geriatric bull is itself a “bug”.

No sooner had market participants shaken off a Franz Ferdinand moment at Baghdad’s international airport than a dangerous infection climbed out of a live animal at a wet market in Wuhan and spread among the locals. Fast forward a few weeks, and the world has a mini-pandemic on its hands.

The World Health Organization on Thursday declined to declare a global health emergency, but officials confirmed the first death outside of the virus’s epicenter. Thursday also brought news that the bug has spread to Singapore, which joins mainland China, Hong Kong, Taiwan, Vietnam, Japan, Thailand, South Korea and the United States, on the list of locales affected by the virus.

On Friday, China said the death toll from Wuhan virus had risen to 25.

To be sure, not all markets and assets have been immune. Outsized losses are already in the books for some regional gauges, mainland sectors, individual names and specialized vehicles (see here and here for a complete rundown).

But US stocks – and particularly tech – are resistant. The S&P is flat this week. The Nasdaq 100 was up 0.5% through Thursday, gunning for a seventh consecutive weekly gain. Big-cap tech has risen in (get this) 15 of the last 17 weeks.

We’ve spilled enough digital ink this week obsessing over tech and whether or not it’s “due”, so to speak. Rather than reiterate those talking points, let’s instead step back and think for a moment about what got us here.

Say what you will about the prospects for a hockey stick-type inflection in earnings growth coming off what, if expectations are borne out, will be a second consecutive quarter of negative profit growth. The bottom line (figuratively and literally in this case) is that we’re in the midst of the first earnings recession since 2016. The red bars (below) for Q1 ’20 through Q4 ’20 show the expected “hockey stick” inflection.

We’ve been over this before, but 2019’s blockbuster gains were all valuation expansion – helped along by the largest net easing impulse (i.e., net rate cuts globally) in years. That doesn’t bode well historically (see the chart below).

“In 2019, investor sentiment and a lower discount rate did all the work, but the Fed can’t come to the rescue every year”, BofA reminds you. “Over the past decade, bond yields fell 210 bps to 1.8%, the Fed was mostly at 0%, and the SPX P/E multiple rose 4 points to 20-year highs”, the bank adds, before warning that “the next 12 months and next 10 years will need more than just a pretty yield chase”.

(BofA)

US equities are trading at nearly 19X on a forward multiple. If that inflection in profit growth doesn’t materialize, it’s hard to imagine there’s much more scope for valuation expansion, even if sentiment remains some semblance of buoyant. “At 2.4x book value, global equity valuations are nearly two standard deviations above normal”, BofA cautions, in the same note. “2020 is a year for reality to catch up with hope”.

And yet, the bank – and it’s hardly just them – is convinced that the expansion isn’t going to die of old age. Why? Well, it’s the notion that the cycle has been “tamed” – that booms and busts are less frequent, even if, when they do occur, they are more spectacular.

“We are in the longest economic expansion since the Civil War, with the longest time between recessions and the longest period of consecutive job gains on record”, the bank reminds you, on the way to rattling off some statistics as follows: “Before the 1980s the economy was in recession 35% of the time [but] since then the figure has fallen…18% in the 1980s, 7% in ‘90s, 22% in the ‘00s, and 0% in the ‘10s”.

(BofA)

That’s correct, of course. But only until it’s not. And the problem with this kind of thing is that, as we saw in 2008, nobody cares about the extent to which efforts to smooth out the cycle have been successful when there’s a recession. If you’re unemployed suddenly, those charts are going to be small comfort.

And besides, are we absolutely sure that manufacturing doesn’t matter anymore? Or maybe it’s just ISM. Because plotting IHS Markit’s gauge doesn’t produce similarly foreboding visuals. Here’s ISM with GDP (for the thousandth time):

And here’s ISM with payrolls:

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Anecdotally, we’ve reached another one of those moments where more and more market participants seem to be questioning whether it even makes sense to talk of “selloffs” or “corrections”.

Maybe stocks aren’t things that fall anymore, just as cycles supposedly no longer turn.

But what is a “cycle” that doesn’t turn? Not a “cycle”, that’s for damn sure.

And let us not forget that a mere 13 months ago, we were mired in the worst December for US equities since the Great Depression.

Anyway, who are you and I to be asking questions, right? Just take the free money, one supposes.

Besides, history tells us that 2020 literally cannot be a down year. As BofA’s technical strategist Steve Suttmeier notes, when January is up, full-year returns for the S&P are positive 100% of the time in Presidential election years.

(BofA)

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