Wow. Where do we begin?

Wow.  Where do we begin?

It has been an incredible week in follow up to the last.

Relentless news flow on the virus and the actions to contain it by business and government leaders.  An upending of the Democratic primary to put Biden in the lead candidate position.  An emergency cut of 0.50% by the Federal Reserve and the market expecting still more.  Treasury yields dropping like a rock with the nominal 10yr Treasury yield falling below 1% for the first time in history (and falling near 0.7% at the low).  Mortgage rates falling so low that banks cannot handle the refinance volume.  Bank stocks tumbling as a result. OPEC+ failing to reach an agreement on Friday for a production cut causing spot oil price and energy-related stocks to fall even further. The list goes on.

Daily swings of 2% to 4% in the broad US equity markets and somehow the major indices (DJIA , S&P 500, Nasdaq) all finished higher for the week.

To be clear, a market correction of 13% in the S&P 500 such as we have seen since the most recent high on February 19th is completely within the bounds of normal equity market behavior.  According to analysis by JPMorgan, the average intra-year S&P 500 price drop over the last 40 years (1980 – 2019) is 13.8%.

What is not normal is the daily price action and intra-day volatility.  This is an equity environment driven by emotions and guesses, likely exacerbated by the volatility-enhancing nature of a fragmented, electronic market structure and momentum-oriented participants (high frequency traders, trend followers, exchange-traded fund creation/redemption process, etc.).

Unexpected loss of human life, from a virus outbreak or otherwise, is tragic.  Setting that aside, the economic and financial impact at this point is driven more by the efforts to contain the virus than the virus itself.  While we are watching for a tapering in new cases, for our financial work we are keenly focused on the business and government responses and what they imply.

Based upon the policy responses thus far, there will clearly be economic impact.  Statistics for Q1 and Q2 (when we get them) will not look pretty.  The real question is whether the impact to growth will be transitory (i.e. the loss of demand will snap back as health concerns settle) and possibly counter-balanced by fiscal response (assuming it appears in sufficient size), or if it will be enough to tip us into recession.  Bond yields are worried, but we are watching the US consumer as our canary.

When will this end?  The market is guessing right now because it does not have enough facts to make an informed opinion.  Looking at the virus case cycle in China, new cases are now in decline.  Would you be surprised to know that the Chinese stock market (CSI 300) is up 3.8% since February 19th (when the S&P 500 hit its high)?  It will be several weeks until we have the data on cases outside of China to see if the cycle follows the same pattern which would give government/business leaders (and the market) some relief.

What should we do?  Keep a level head.  While you never know what will be the cause, bouts of fear in the equity market are inevitable.  So are recessions, corrections, and (eventually again) bear markets.  There is always something to worry about, and occasionally a worry becomes a problem.  The problem gets resolved in time and equity markets move on.   With diversified asset allocations appropriately focused on quality, these turbulent periods create opportunities as expectations overestimate the likely reality (and price dislocates from value).  We are tracking several such opportunities but being patient for when we have enough fact for an informed opinion.

Historically, it takes a little time bouncing along a bottom and re-testing a low to repair sentiment and allow some rationality to return.  Then it all begins again.


Will Skeean, CFA

Partner – Investment Management Team Chair