The Invisible Enemy Is Priority Number One
It has been a difficult month for investors. Since the February 19th peak, the S&P 500 Index has shed 34% to its most recent low (St. Louis Federal Reserve). That’s roughly in line with the average bear market pullback (LPL Research), with bear markets being defined by at least a 20% sell-off.
However, the rapid decline in the major stock market indexes has been unsettling. The 34% drop occurred in just over one month. It’s unprecedented.
But what we are seeing in the economy is without precedent, too. There is an enormous amount of uncertainty. These are the same industries that were touted as saviors for malls and shopping centers and were immune to the biggest risk faced by many retailers – the internet. Now, these businesses – considered non-essential and that require person to person interactions – are being shut down. And many of the service-related companies that remain open have seen a significant drop in traffic.
Since there is no modern precedent on which to model economic forecasts, the second-quarter projections for GDP have been incredibly wide. Similar challenges exist for evaluating companies. Any article that touts how cheap a stock is trading is merely a gamble that it will recover faster than the overall market.
Think about this: in order to figure out what a share of Starbucks is worth, analysts would forecast out their revenues – which includes the number of lattes being sold at a given price. But with no idea when stores will reopen and how quickly consumers will return to their normal routine, it’s impossible to put a value on anything. The next time you see an article titled ‘Now is the best time to buy X company’ or ‘X company has Y% upside’, delete it. It would be the same as me suggesting that the next spin on the roulette wheel will be red because the last 10 have been black! Good luck with that.
If we connect the sporadic and contradictory dots, the economic uncertainty has translated into earnings uncertainty which in turn has translated into incredibly volatile markets and no one, I mean no one, can reasonably predict the next 12 months. This is why a long-term view is critical. Looking past 2020, maintaining a focus on long-term plans and goals, and making methodical and prudent decisions is the way to go.
A government-induced economic coma
In order to slow the spread of the pandemic, the government has encouraged social distancing, and several states have ordered lockdowns or strict shelter-in-place mandates. You may go outside to exercise or head to the grocery store, but there is a ban on social gatherings, which would spread the virus. Some grocery stores have even imposed one-way aisles – something that in retrospect, might not be such a bad idea to keep.
While social distancing will slow the spread of COVID-19, the economic impact has been unparalleled. In a way, the government is putting key sectors of the economy in a coma, as it hopes to stem the spread of the virus. When health and safety dictate, the goal is to bring the ‘patient’ out of the coma. Unfortunately, some of those patients won’t survive. Small businesses that rely on a steady flow of business might have to shutter their doors, barring some financial engineering genius that can keep them afloat until things normalize.
But policymakers aren’t expecting the economy to bounce back on its own. If shutdowns are encouraged or enforced, policy is being put into place to revive the patient when the time comes – and again – if the patient is still alive.
The government response to soften the expected economic blow has been extraordinary and goes well beyond what we saw during the 2008 financial crisis. If the 2008 response was a bazooka, the response we have seen so far is an atomic bomb. Unfortunately, we might need to go nuclear!!!
The Federal Reserve has not only dropped the fed funds rate to zero, but it has implemented several programs designed to support Treasury bonds, investment-grade corporate bonds, commercial paper (short-term IOUs issued by the largest corporations), money market funds, mortgage-backed securities and municipals.
Further, a new program designed to support small- and medium-sized businesses will be forthcoming.
During the financial crisis, the Fed’s focus was on Wall Street and critical credit markets. Today, the scope of support extends well beyond Wall Street and into Main Street. Certainly, this has been a more balanced approach in that the stimulus is aiding both corporations and individuals. There will still be bickering amongst politicians and constituents that lean to the extremes, but in my opinion, this $2 trillion package was certainly broader than the one in 2008.
In addition to mitigating some of the damage from surging layoffs, the Federal Reserve and the Federal government are trying to put a foundation in place that will support a robust economic recovery.
Will it work? Much depends on the duration and severity of the recession and the path of the virus.
Road to recovery
I see four steps that are important.
- A massive response by the Federal government and the Federal Reserve. I think we can check that box. While continued volatility is likely, a modest rebound from March’s low was fueled by the Fed and the $2 trillion stimulus plan. The question is whether it is enough – particularly when new cases reported are still accelerating – even if it is due to higher testing.
Other pieces of the recovery puzzle include:
- A peak in new U.S. cases and subsequent decline.
- An effective treatment and vaccine.
- Clarity on the economic data. What will be the steepness and duration of the recession?
No one rings a bell that sounds the all-clear signal. Collectively, markets attempt to price in future events. Given the wide range of outcomes, volatility has been the rule.
But stocks will likely bottom before the economy rebounds – and this is important to note. If you wait until the economy rebounds, there is a good chance you will miss a robust recovery in the stock market. So at some point, if you have cash to invest – and as painful as it might be – it will be time to put it to work BEFORE we get an all-clear.
Thoughts
I spend an enormous amount of time discussing the importance of your financial plan. It is our roadmap in good times and bad. It is based on a simple premise: stocks rise more than they fall, and stocks rise more than they fall because historically, the U.S. economy has expanded over time.
I understand that what is happening is unprecedented. We are in the midst of an economic and health care crisis. Both breed fear and uncertainty – which according to conversations, leads to paralysis!
But I am confident this pandemic eventually will pass, and I am confident that the underlying fundamentals of the U.S. economy remain strong. Resilience and ingenuity are part of the DNA that make up America. We will persevere and we will recover.
If you have questions, concerns, fears, and doubt–well, I get that. I really do. And please remember, my door is open. I’m always available.
