Where Do the Markets Go from Here? Beware the Market Rally!

I wish I could believe we are enjoying a V-shaped recovery. I can think of no better wonderful response to the horrible 23 trading days between February 20th and March 23rd than a "V" to erase that decline. Here is why I think this a dangerous rally.

First, let us get our numbers straight. If someone told me the market declined 35% but was already up 25%, so it's now really only down 9%, barely enough to call it a correction, they would be wrong. A 25% rally up from down 35% equals down 18.75%.

My biggest concern about this rally is it has little support beyond what was being supported before the decline. When reality sets in, we might have unemployment of 25% (Goldman), industries in complete and total disarray (airlines, hotels, cruise lines, restaurants, and all the supporting industries), and energy companies unable to sustain profits at current oil prices. Will oil ever get above $60 again?

Leadership before the decline rested with the FANGMAN stocks and they continue to lead this rally. we believe, investors did not take the time or give proper attention to examine whether their price-to-earnings ratios were sustainable. That may yet prove to be a brilliant move, but there are those of us who see the rush back to FANGMAN as not well thought out and not taking advantage of the fact that this rally may be providing an opportunity to sell before the next decline.

This will not end well. When the armor cracks, as it always will in one place or another, the rush to exit will be brutal.

In my mind, leadership in this rally stinks. Valuations are approaching levels in some cases where they triggered the decline. And while the market does predict the economy six months to a year or more out, in this case, it seems the market is predicting a far better outcome in that time frame than I think is realistic.

All this is aided and abetted by Wall Street, of course. About 90% of the sell-side analysis say, well, yeah, 2020 doesn't look so hot for earnings except maybe the fourth quarter (we are in Q2 now and still in lock-down most places), but, boy, we expect 2021 to be a barn burner!

And what about the housing market? This is prime spring selling season, but sales have ground to a halt. Buyers are absent and listed homes are languishing on the market. A conservative estimate is at least 15% of homeowners will fall behind on their mortgage payments causing delinquencies, which is why we have seen tightening of lending standards.

The last time there was a housing market bubble, it took four years to start to settle. This summer or in the fall expect lower appraisals, which will affect sales as buyers are offered smaller mortgages and, more importantly, existing mortgages start to have too high a percentage of loan-to-value ratios and the banks start calling. Unlike the last housing market correction, this time buyers and sellers cannot tell appraisers the value they need.

The take on the old view of these ever-exchanging cycles begins, as most do, as if we are coming out of a bear cycle. This chart shows the S&P 500 from the beginning of the bull cycle that began in March 2009 through May 13, 2020.

bigcharts.com as of May 13, 2020

And now for the fun part. Or maybe not, if the composite history of other bear cycles proves prescient for this one. You can talk economics, technicals, fundamentals, and so on all you like, but let's face it: the market is a product of, and a result of, human emotion. Prepare for a long drawn out visit to the prices of early March or lower and continued extreme volatility!

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