First and foremost, we hope that you and your families are safe and healthy during this difficult time.
As the country copes with the human impact of COVID-19, the strain on markets and the economy have been swift. There is no precedent for what is happening on Wall Street. The reason, of course, is that the primary trigger came from an external event (COVID-19), rather than monetary pressures or economic imbalances – as are most cyclical peaks. Therefore, economists and seasoned investors feel blindsided today, even though there were underlying risks already present.
The path ahead for this bear market is very murky. The major problem is that monetary stimulus and fiscal policy cannot halt a stubborn viral pandemic, but that has not prevented authorities from trying. The Fed did the first emergency rate cut since the financial crisis, and then cut rates to zero a few days later. They will help business with up to $1 trillion in short term funding. Washington is talking about bailouts and deferring tax payments along with sending $500 billion in checks to Americans.
The extraordinary efforts to stabilize confidence should have some positive effect, but in our view will not avoid a recession. The challenge lies in the lofty level of stock market valuations, vulnerability of real estate prices, and unknown default risk from low-quality debt. These risks will determine the depth and duration of the recession.
The swiftness of this stock market plunge provided little or no opportunity for a profitable (or even unprofitable) exit. We suspect upcoming rally attempts will be met with investors continuing to sell in an effort to reduce losses. That would mean that a bear market bottom will likely require months to develop.
That said, not all bear markets are created equally. Goldman Sachs analyzed bear markets going back to 1835, and then classified them as Structural, Cyclical, or Event Driven.
Goldman defines Structural bear markets as those created by imbalances and financial bubbles, very often followed by a price shock such as deflation. Cyclical bear markets are typically a function of the economic cycle marked by rising interest rates, impending recessions, and falls in profits. An Event Driven bear market refers to things like the war, oil price shocks, or an emerging-market crisis.
Structural bear markets, on average, see drops of 57%. Cyclical bear markets see average drops of 31%. Event driven bear markets usually experience declines of 29%.
Structural bear markets take 9 years on average to recover, Cyclical take 4 years on average, while Event Driven typically recover in one year or less on average.
Goldman researcher Peter Oppenheimer see differences, however, between the current situation and other “event-driven” declines.
“They’re all different, but typically it has been market driven, so a monetary response has often been more effective, whereas this time it’s not clear that it will be. This is partly because interest-rate cuts may not be very effective in an environment of fear where consumers are forced, or just inclined, to stay at home,” he said. He went on to say “none of the previous examples were in periods where the starting point of interest rates has been so low”.
Might a V-shaped economic recovery be in the works?
In Q1 1958, GDP fell 10%. While the research is somewhat lacking, the 1957-58 outbreak of the Asian flu appears to be the culprit behind a 10% drop in Q1 GDP in 1958. Growth returned the following quarter, with GDP expanding 2.7%. We also experienced a seven month contraction that coincided with the deadly Spanish flu epidemic of 1918–19. When the epidemics ran their course, the economy recovered.
Further, massive monetary and fiscal stimulus is likely to limit some of the damage and help set the stage for an eventual economic recovery.
The good news is that the best buying opportunity in over a decade lies ahead! The 1987 bear market is one historical precedent that is perhaps most like today. The bear market unfolded quickly after the top, losing 20% in just 38 days and hitting the final bottom 3 months later. This time we hit the 20% down mark just 19 days after the top, and will have to wait to see where the bottom lands. The 2007 market was a more protracted downturn that lasted 18 months and had several enticing rallies before finding a bottom. We will be patient and wait for the evidence to tell us when the time is right to start increasing our invested allocation.
We must also remember the market peaked barely 4 weeks ago on February 19. We believe that there is a lot more bad news heading in Wall Street’s direction – both economically and financially. Today, every indication is that this bear market has further to run as the economy comes under increasing pressure. We are defensively allocated for the growing probability of what might become a more protracted bear market. With some reserve cash, we are positioned to take advantage of the next low risk buying opportunity when it appears.
Let us not discount the human toll and those who will not recover from this virus. We will all likely know someone who eventually contracts the virus, and tragically, someone who does not survive.
As we deal with this big awful mess please consider this note sent by a long time SVWA client and friend. She writes “I’m remembering something that happened to me when I was in high school. One morning I went out in my yard and found my dog, a whippet, stretched out in the grass, with a tiny wood duckling between his front paws. Neither animal moved. The dog was ready to pounce. But the duckling, small enough to fit in a teacup, held perfectly still. It knew if it panicked and ran, the dog would kill it. This gave me time to scoop up the duckling and take it to wildlife rescue. I’ve never forgotten the calmness of that little thing as it waited out a bad moment. A great metaphor for dealing with the market, I think.” Indeed!
The great Roman philosopher Seneca wrote in his 13th letter “there are more things…likely to frighten us than there are to crush us; we suffer more in imagination than in reality”.
Please note that as of this writing we are invoking our Business Continuity Plan; part of the staff is working remotely while others are working in one of our three offices. All employees are using devices that are encrypted and access is secure. This allows us to split the staff and employ “social distancing”. If you have any reason to visit one of our locations, please contact us ahead of time so that we can discuss the proper protocol. We are always happy to conduct virtual meetings to stay connected, discuss financial planning and investments needs, and to field any questions you might have.
Thank you for your support during these challenging times. Our hearts go out to you and hope you are staying safe.
Best,
Silicon Valley Wealth Advisors