Written by: Ryan Unthank
As the global health crisis intensives in the United States, government officials are scrambling to find faster medical solutions and are already discussing additional economic responses on top of what they just passed Friday. All the while, the markets continue bouncing around like a pin-ball machine and everyone is scrambling to call a bottom. Whether the market has hit its lowest point or still has more to go, I promise you that no one knows, but what we do know is that market bottoming is a process where it will likely decline again to retest the lower levels as it finds its bottom before it climbs back to new highs. In the meantime, we thought it might be helpful to share the answers to the most popular questions we are receiving, remind everyone the important lesson on market timing and tell you the singular question you should be asking yourself. We hope this helps calm your nerves on some level. Please feel free to share this with your family, friends and coworkers as we all stay in the safety of our homes right now. As always, call us directly if you want to discuss any of these topics further.
Are we on the verge of the next great depression?
Although we cannot assign a 0% likelihood of this worst-case scenario, the recent magnitude of fiscal and monetary support has drastically diminished that possibility. It’s also incredibly important to define the difference between a recession and depression. A recession is most commonly referred to as an economic contraction that lasts at least two quarters. A depression is an extended recession that lasts multiple years, not quarters. Specifically, the 1930’s Great Depression lasted over a decade. The policy responses that we have that we didn’t see in the 1930s include: loosened monetary policy, regulations, taxes and an easing trade war.
The Fed’s balance sheet has ballooned to over $5 trillion and they have successfully thawed a rapidly freezing credit market by purchasing treasuries, mortgage-backed securities, commercial paper and recently adding municipal and investment grade bonds to their arsenal. This is important because as the credit markets freeze then access to capital for corporations, small businesses, private equity, etc. becomes non-existent. When combining this monetary policy with the fiscal response of over $2 trillion in stimulus, it becomes more likely that we will be able to patch the giant hole created by the health crisis.
Has the stock market bottomed?
March 23rd has so far marked the low with the S&P 500 hitting an intra-day low of 2,190. This represents a decline of about 35% from its peak on February 19th. With the anticipated passing of the $2 trillion fiscal stimulus, the markets ripped higher by over 20% in 3 trading days, marking the end of the shortest recorded bear market. Craziness! Violent swings down and then back up are not strangers to bear markets. Bottoming is a process and since typical fundamental valuation measurements are not always going to be helpful in these conditions, we must look to internal trading patterns to help us gauge how far the fall will take us.
We look at the number of new stocks hitting 52-week lows, the options market, investor sentiment and treasury yields as a source for market internals. We also look at history as a guide to define typical bear market declines, durations and patterns. Ultimately, most bear markets of this significance will have waterfall declines followed by strong but brief rallies only to eventually roll over and retest the previous lows. We don’t know what this one will look like but improving health data will be the ultimate turning point. We are around 2-4 weeks behind the trajectory of Italy so we can expect the confirmed number of cases and casualties to get worse before it gets better. In order for investors to return with confidence, we will need to see an improvement in the slope of the infected cases to level off.
Who are the long term winners and losers after the dust settles?
Globalization and inter-connectiveness of world economies during this century have brought with it strong economic growth and lower inflation. Outsourcing of certain enterprise functions and supply chains are examples that have lowered costs for corporations. We feel big changes are in store on this front. For example, over 95% of antibiotics used in the United States are manufactured in China. There will likely be significant changes going forward and whether the supply chains are moved to other countries or brought back and manufactured domestically, this could create more pronounced inflation in the future.
We feel it will take time for socialized gatherings to normalize (concerts, sporting events, etc.) but they should resume when people feel comfortable again. In the meantime, there will be pain in the entertainment and travel industries and likely some casualties. The best capitalized and managed businesses will make it through this severe contraction in demand. Those companies positioned to prosper in a new dynamic will take market share and become bigger. Video conferencing and socializing, cloud-based solutions, e-commerce and digital payments have secular dynamics that will create steady growth and opportunities.
A lesson on market timing
Our reminder on the challenge of market timing can be seen on the following chart which illustrates how important it is for the average long-term investor to focus on the big picture instead of the emotions of stock market swings. The chart is from a research report published by Strategas, which essentially illustrates how important it is to stay the course. Very few people, including professionals, can consistently exploit these wide swings in their favor. We constantly try to remind our clients how important their long-term planning is to their financial success. Bear markets come and go. Eventually a new bull market will emerge out of this and will set the stage for better expected returns for certain asset classes going forward. By selling out of stocks and expecting to get right back in when markets are lower, in theory, sounds like the best solution. However, in practice, human emotions prevent those people from getting back into stocks until they have already trended higher.
If you or someone you know is feeling anxious and unsure of what to do during this bear market, please give us a call and we will be happy to review your assets and create a customized plan that improves your financial security.
The only question you need to ask yourself
Did you have a Financial Plan going into this volatile market? If your answer is “yes” then has there been an unforeseen change in your cash flow needs that would change your previously determined goals? We say this because we take great precautions in using conservative assumptions in our clients personalized plans. We also stress test the plans against situations just like this which allows us to understand the various pressures the plans can withstand or determine what changes need to be made for clients to be successful in these turbulent markets. So, if you or someone you know is feeling anxious and unsure of what to do during this bear market, please give us a call and we will be happy to go over your plan with you or review the assets of a friend and create a customized plan to improve their financial security.
Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.