Feb 28, 2020
Current Perspective on Markets
It has been a while since market conditions have compelled us to send a short note like this between quarters. Our intent here, as we have done in the past, is to provide perspective on volatility and offer a few thoughts regarding expectations and how to deal with those things that are in our control.
Stocks have rapidly declined into bear market territory, marking a sudden end to the longest bull market in history. The news flow has been fluid and evolving quickly. We thought it would be helpful to summarize some of the key changes over the past few weeks.
- The objective of containment is now being seen more realistically as a matter of mitigation. The official declaration from the World Health Organization that COVID-19 is an official pandemic should come as no surprise to most, given the developments of the past week. Estimates on the potential infection rate in the U.S. are still wide ranging, but it is now believed that the virus will be or is already present in virtually every community. On the plus side, symptoms are still expected to be relatively mild for a large majority of those infected.
- From the market’s perspective, the fear of the economic impact has transcended the fear of the virus. The recent announcements from communities and corporations curtailing travel, canceling events, furloughing employees, and encouraging people to stay at home is now seen as too little, too late. The question of whether were are entering a recession is becoming less of an issue as the markets are already factoring in that inevitability and more. Closer to home, our daily routines are being disrupted in ways more akin to the uncertainties that followed the exogenous shock of 9/11.
- Data from China and South Korea have shown that draconian measures to contain social interaction is effective. The inability or unwillingness to enforce this authoritarian behavior, like that experienced in Italy and Iran, risks high infection rates. U.S. policy is still taking shape, and while the most severe response was never seen as a feasible option, markets are telling us that we are behind the curve in terms of implementing potential control procedures. That is now changing fast.
- The need to support the economy on the fiscal side, either from tax relief, financial help to small businesses, or a major infrastructure initiative has yet to take shape in final form with bipartisan support. While something material along these lines is expected any moment, the absence of progress here and indecisive leadership is being blamed for a good part of the market’s weakness the past couple days.
- The sudden collapse in oil prices due to the impasse on production quotas between Russia and Saudi Arabia could not have come at a worse time. As we saw in 2015, weakness in the broad energy complex has far-reaching implications on the U.S. economy and in particular, the credit markets. Any progress in reaching a middle-ground compromise between the Saudis and Russia would come as a great relief to the markets.
- Bond yields have also collapsed in tandem with the economic outlook, bringing the yield on a 10-Year Treasury to as low as 0.50%. Additional rate cuts are now expected to bring the Fed Funds rate close to zero. This and other potential monetary responses from the Fed are not expected to provide much net stimulus to the economy, but they do play an extremely important role in helping to avoid the kind of liquidity squeeze that undermined confidence during the Financial Crisis.
- More recently, the markets are experiencing pressure on credit spreads, which means bonds and stocks of lower quality companies are showing additional weakness. The pricing of risk in lower quality investments has reflected complacency for many years. As the odds of recession have increased, this increase in risk aversion is probably overdue.
None of us knows how long these conditions will last, though it is sinking in that it may be months before there is more clarity on the growth rate of infections in the U.S. and the eventual impact on businesses. In the meantime, the flow of news promises to be challenging as more data points come to light. We are told that this strain of the coronavirus may be with us indefinitely, like other flu viruses that make an appearance on a seasonal basis and are controlled by vaccine and effective treatments. That sounds like a reasonable outcome from where things stand today.
With the unfortunate turn of events, our highest and best use at this time is in two areas:
- Continue to do our daily job of operating our decision-making process by assessing individual securities for quality and price/value opportunity, and making shifts where we believe we can improve the return opportunity for the future. Sometimes that means buying a fundamentally attractive company, now overly discounted due to the market’s decline. Sometimes that may mean taking a loss where the fundamentals have changed or to lighten up in an area for risk management purposes. Our focus right now is to take advantage of what the current market is giving us to improve the long-term opportunity for your portfolio returns.
- Provide some additional context to what we are going through. While the circumstances of this decline is unprecedented in many ways, the markets have experienced eight bear markets since the 70’s with declines between 21-54%, and 13 corrections with declines between 11-19%. Since the last major bear market which bottomed in 2009, there have been five significant corrections (declining between 12-19%). Despite these pullbacks during the past decade, equities provided a well above-average gain of 12-15% per year.
One thing we believe will remain true is that a bottom will form well before the news gets better. We want to participate in the recovery when that happens. We have been here before and we are confident that our people and processes will enable us to emerge from this bear market successfully on your behalf.
We will likely be passing along additional updates as we learn more.
All of us appreciate the responsibility you give us to work with you through these unusual times. We encourage everyone to listen to the advice of medical science experts and apply the rational precautions they suggest to protect against this very transmissible disease to keep you and your loved ones healthy.