Market update: Risk assets in a bear market
Friends,
The last few weeks have been history-making for global stock markets, but today was especially notable. We’ll let a graphic for the US markets illustrate (see above).
Today was the worst day for US stocks since 1987, when markets fell over 20%. But the point drops today are even more extreme. The Dow, a narrow index of 30 large cap US companies, but one closely watched by many, fell 2,352 points. Looking at the one month chart makes the recent moves seem even more extreme (see right). Global markets fell overnight as a result of an ever-mounting list of bad news. At the opening bell, US markets were down significantly, triggering a trading curb and halting trading for 15 minutes. Broad indices closed decidedly down for the day, with all US equity averages down over 9%. The small-cap Russell 2000 was down over 11%. European markets closed down in similar ranges.
By midday, the Fed stepped in and announced a $1.5 Trillion package to inject liquidity into the short-term money market. Stocks briefly rose on this news before retreating back to their lows within minutes. This indicates a crisis of confidence, more on this later.
The one month charts show the medium term declines have put us firmly into bear market territory, with all major US indexes now down over 25%. The indexes have also moved below their 50 month moving average (a key technical measure).
Under normal market conditions, we anchor ourselves using fundamental equity valuations. In times of extreme volatility, we begin to lean more heavily on what are called “technical” or “chart” analyses. We do this because volatile markets indicate a sudden shift in expectations for future returns and risk. In such an environment, valuation measures are uncertain because the underlying assumptions (earnings, creditworthiness) are questioned. Most risks remain to the downside, not only because of pandemic concerns, but also because we are at the tail end of a long boom which has driven valuations up to extreme highs.
Looking ahead, there are several key levels of interest. In December 2018, the S&P 500 reached a low of 2416. This is a major psychological level and we are approaching it. From a technical perspective, we would expect further downside if this level is convincingly breached.
We also want to emphasize that today’s downward moves extended to all markets, including bond markets. There are a flood of margin calls across the street at the moment, as well as a desire to hoard cash on behalf of many companies uncertain about the near-term sales outlook. This has led some investors to sell indiscriminately, accepting a haircut on many assets. This need for cash has caused bond bids to dry up and we’ve seen short-term investment grade corporate bonds trade below par (very unusual in a low interest rate environment where investors are seeking safety). We believe this is due to transitory liquidity concerns that the Fed is well placed to address and expect these bonds will come back in price as the Fed’s policies help stabilize the credit market.
The underlying cause of the stock market decline is, however, not something the Fed can do anything about. The WHO has declared the Coronavirus a global pandemic. As we discussed two weeks ago, we believe the measures required to slow the spread of Coronavirus are extreme, and will impact the real economy. A global recession looks all but inevitable at the moment. This fact is a big part of what’s driving markets down.
Worse, rather than hitting all at once, the bad news is coming in at a steady dribble: sporting events cancelled, flights halted, all retail closed in certain countries, domestic travel restrictions, schools closed, politicians quarantined, celebrities infected etc. etc. etc. There is no respite in sight. It seems certain that the “social distancing” measures recommended by public health authorities will have an impact on corporate earnings for this quarter and the next. Small and large firms will see a sudden shock to cash flow, and this will impact their ability to service debt and continue business operations.
Perhaps worst of all is the lack of information in the US. There are credible reports in the media that the executive branch has sought to limit testing for Coronavirus because it believes a rise in the number of confirmed cases is politically damaging. This is a dangerous development which puts the health of millions at risk. The president has also tried to downplay the seriousness of the disease, again placing lives at risk.
South Korea, in the past 24 hours, has probably done more tests for coronavirus than the United States has done in the past two months. South Korea can administer 10,000 tests per day. At last count, the US has done somewhere between 5,000 and 8,000 tests in total. — https://www.npr.org/2020/03/12/814881355/white-house-knew-coronavirus-would-be-a-major-threat-but-response-fell-short
The population of South Korea is 50 million. The US population is over 300 million. It has rapidly become clear to market participants that no one in the US has any idea how bad the spread of this virus already is. South Korea and China appear to have been successful at containing the pandemic. The chances of the US doing the same now seem very remote. In the absence of accurate information as to the extent of the disease’s spread, market participants are free to speculate. Questions have been raised about the veracity of information coming from this administration, and its response has been haphazard. The travel restrictions with Europe were not coordinated with European entities and took them by surprise. We do not believe a sudden outbreak of competence is imminent. All of which leaves us here: we do not know yet how widespread the epidemic is, or what impact it will have on our healthcare system. There is no clear indication as to how long US regions will need to practice social distancing and other measures to limit the spread of the virus.
All the news, rumors and lack of verifiable information is weighing heavily on risk assets. Our advice to clients and readers continues to be to maintain caution under the current market conditions.
Now, with this said, let’s all take a deep breath. While markets are volatile, it can be very easy to lose perspective. Yes, we are the midst of a very challenging crisis, but this too shall pass. As investors, our job is to carefully consider the current market conditions, but also think about where markets will be months or years from now. For investors with a long time horizon, it’s important to remember that markets move in cycles, corrections are part of a functioning economy and risk assets outperform over the long term. Falling asset prices can present great buying opportunities for investors who are patient and prepared. By positioning portfolios defensively in the months leading up to this crisis, we now have the opportunity to become more aggressive when valuations are low and stocks look cheap again. Our plan is to reallocate into underpriced risk assets when the time is right.
Please contact us if you would like to discuss your portfolio or investment allocation.
Regards,
Subir Grewal, CFA, CFP Louis Berger