The Pendulum Swings

Published On: March 19, 2020

Written by: Ben Atwater and Matt Malick

On January 17, 2020, Barron’s, a weekly investment tabloid, ran a cover story entitled “The Method Behind the Melt-Up: Why the Dow Won’t Stop at 30,000.” 

The article cited an obscure (or possibly situationally invented) valuation metric called “price-to-cash returns” to argue that stocks were cheap when viewed as a multiple of cash spent on dividends and share buybacks.  We had never even heard of “price-to-cash returns.” 

While the article acknowledged stocks could be considered expensive based on nearly every other measure of valuation, the general gist of the article was stocks were likely to continue melting up thanks to low interest rates, muted inflation and massive stock buybacks. 

Following the article’s publication, the Dow Jones Industrial Average never did hit the 30,000 mark and has instead lost nearly a third of its value.  Now that several industries are seeking government bailouts to stay afloat during the coronavirus pandemic, including aerospace, airlines, hotels and cruise ships, stock buybacks (and even dividends) seem unlikely to resume for a very long time.

We mention this article not to pick on Barron’s for getting it wrong but, rather, to point out how far the pendulum swings when it comes to financial markets.  When times are good and stocks are rising, investors will go to an extreme to justify valuations and explain why further gains are inevitable. Barron’s was simply reporting widely held sentiment among most investors just a couple of months ago. 

Likewise, when markets are crashing, pessimism abounds, and the pendulum swings to the other extreme. 

Yesterday Barrons.com posted an article called “Could Coronavirus Lead to a Depression? Economists Are Worried.”  To support fears of a depression, the article cites a troubling New York Fed manufacturing survey, poor economic numbers coming out of China as they continue to battle the coronavirus, a Federal Reserve with limited room to cut interest rates, low oil prices pressuring the energy industry, and upcoming presidential election uncertainty.

While a recession is a foregone conclusion at this point, and the risks that Barron’s mentions are certainly real, headlines about a second depression complete with a picture of a 1930’s breadline may be a sign that we are in the process of overshooting to the downside. 

A bear market bottom forms, by definition, when pessimism reaches its maximum.  Things surely seem dark right now.  It’s not historically unusual though to see bear market drops of 50% or more.  At present we are down a little over 30% from all-time highs.  This means we probably have further to fall, but we continue to look for signs of a bottoming and this latest Barron’s article is certainly one of those signs.