Markets Look Forward after Massive Selloff

By Ketu Desai

What a horrific month for investors, the sell-off was historic and unprecedented. The selling at times was indiscriminate, as many levered players had to liquidate. The selling reached a new level after Saudi Arabia and Russia failed to agree on a deal, oil tanked, and this caused many that were levered long oil to sell across their portfolio. As they sold other asset classes to meet margin calls, this caused other levered players to liquidate, and the domino effect was in place. This forced selling, combined with poor liquidity, was an important factor in causing these historic moves. The economic data will be bad, especially employment and service sector related data. Second quarter GDP will show a very sharp and deep contraction, likely a double-digit contraction. The data will be terrible across most of the developed world. First quarter earnings will also be terrible, and many companies will pull or cut full year estimates. The good news is that everybody knows this already, and the market will begin to look forward.

Rather than reviewing what happened, let's focus on reasons to remain optimistic for long-term investors. The current period of investing based on fear and margin calls will make way for investing to meet long-term goals and future returns. With rates so low, and negative on an inflation-adjusted basis, investors that need yield or capital appreciation to meet long-term goals will have to invest in equities. The earnings yield on the S&P is more than five percent greater than the 10YR, and the dividend yield is more than double. With the sell-off, very high-quality companies with strong balance sheets, and capital appreciation potential can be bought at attractive valuations. Themes such as 5G, cloud, enterprise software, payments, automation, fintech, gene therapy, and medical innovation may have hit a speed bump but remain intact.

Hedge funds have de-levered, and equities have seen record outflows. Private equity is estimated to have $1.5 trillion in cash. These are all pockets of cash that could find their way into the market. With a new work from home economy emerging, it is possible that the forward returns and yields on many real estate related investments have also been altered, which could be another source of capital that looks to the equity market. While many real estate investments are less attractive now, residential real estate could see increased demand with lower rates and millennial family formation. Each housing start creates four full-time jobs, thus, adding 500,000-900,000 in US starts per year is 2mm-3.6 million additional jobs, which has a significant multiplier effect.

Corporate insider buying hit the highest level since March 2009, signaling confidence among executives. The Fed and fiscal stimulus will amount to trillions of dollars of support for the equity markets. The fiscal bill amounts to nearly 10 percent of GDP. The Fed's balance sheet is more than 20 percent of GDP, and is on its way to over 40 percent. Such plans are happening on a global basis. The market has never seen the amount of stimulus that will filter through, and as it does, it is a massive tailwind for markets. History also shows that these types of violent moves down, are often met with a violent move up.

Finally, sentiment and expectations are so beaten down, any upside surprise can spark optimism. The economy will eventually come back online, and as we move to 2021, growth is expected to re-accelerate and the comparable becomes quite low for companies to beat. Hang in there.

Looking forward, the market will digest terrible first quarter earnings and economic data, and stay on top of every virus-related headline.


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( ), an investment management firm based in New Jersey.