What's Going on in the Markets - March 17, 2020

If you took a long hibernation nap starting on Christmas Eve 2018, woke up yesterday and looked at the markets, you'd think that nothing happened. As it turns out, the entire market rally since that day has been re-possessed in what has been the fastest 20%+ sell-off in history.

The Coronavirus infected market continued its downward ways as panicky investors dumped stocks in droves yesterday because of a feared economic recession. With the exception of treasury bonds, all stocks, sectors, industries, commodities (including gold and silver) were hit hard in yesterday's trading.  We are now officially in a bear market, with a mild recession (two consecutive calendar quarters of negative growth) hitting in the next few months being a much stronger possibility.

We have seen a lot of bear markets unfold over the past 40 years, but this one is unique in several aspects:

1.     First, the trigger came from an external event (i.e., Coronavirus) that is totally unrelated to monetary policy. In fact, the Fed has been aggressively “supporting” the market since its policy reversal in December 2018.

2.     Second, there were virtually no confirmation flags of a probable or imminent recession. Instead, consumer confidence was holding near 50-year highs, and the Leading Economic Index had just broken upward to a new all-time high.

3.     Third, the selling has been extraordinarily intense and indiscriminate. In some aspects, this reflects the type of selling panic normally seen near the END of a bear market instead of at the beginning.

The bad news is that we do not have many –or any– historical precedents upon which to rely with respect to the Coronavirus pandemic. The good news is that our client portfolios were defensively positioned with a high cash reserve and bear market funds prior to this panic selling, and has successfully protected against over 30-50% of the downside loss. And with our more conservative sector weighting, it would have been more resilient if not for the universal selling.

With yesterday’s market closing on the low, the volatility is clearly not over. History indicates it would be a mistake to sell additional holdings into this waterfall decline - at least at this time and without any solid warning flags of recession. Nonetheless, if you're worried about your portfolio and are losing sleep, then you probably have too big of an allocation to equities, and it would therefore be prudent to consider lightening up into any bounce that the market offers (which thus far have not lasted much more than an hour or two).

On Friday, President Trump declared the Covid-19 Coronavirus a national emergency, opening the door for an infusion of federal funds to ease the effects of the outbreak at home. In response, the DJIA (Dow Jones Industrial Average index) rallied more than 1400 points in the final 30 minutes of trading, erasing much of Thursday’s record down day.

Despite that positive reaction on Wall Street on Friday, this past weekend saw an escalation of Coronavirus impact and particularly of fear – with travel restrictions and business closures. Although this effect could still be transitory, it's possible that the unwinding of the Fed’s moral hazard (false investor confidence) on Wall Street could have a more lasting impact on the economic and stock market outlook. Even a 1% emergency rate cut and $700B of stimulus offered by the federal reserve could not stop another record decline in the stock market yesterday.

With market conditions as they are, a robust multi-day rally is expected. Indeed, after a lock limit down on the markets again yesterday at 7% down, we had a 5% lock limit up rally in the overnight futures market (Monday night). That could provide for a nice turnaround Tuesday if the bounce carries through the trading day.

While I'm getting calls and e-mails from clients concerned about how far this decline has gone, I'm also getting a lot of calls and e-mails about buying into this decline. Based on what I'm seeing, it seems to be a bit too early to buy, and probably too late to sell. While I thought we might have seen investor capitulation to the downside on the open yesterday morning, that thought proved fleeting as we briefly bounced and came back to close on the lows. That is not encouraging price action. And the fact that so many people are still anxious to buy this "dip" leads me to believe that the bottom is not yet in.

Nibbling on some stocks or funds at these levels isn't a terrible idea, but I prefer an approach that sees us bounce, see where the bounce runs out of steam, and watch for a re-test of yesterday's lows (to see if they hold) at some point in the near future. If the re-test succeeds, then it might be "off to the races" for the markets. If it fails, then look out below.

For that reason, I tend to be patient in buying back into a vicious bear market that will fool you into thinking that the selling is all over, only to drop your recent stock or fund purchase by 20-25% in less than a day.  Averaging down sounds like a great idea until you're down 25-50% on a position in a day or two. It's often better to wait for the re-test of the lows rather than jumping in with both feet too soon. Sure, the market could make you whole and profitable in a matter of months, but if you're looking to compound your annual returns at the highest rate possible, shortening the recovery period to get back to even makes patience essential.

In my opinion, it's probably better to use short-term market strength to trim some positions if you're overexposed to the markets and need to reduce overall risk. If you've been stressed out about your portfolio, IRA or 401(k), then use the bounces to reduce stock and bond exposure. It never hurts to reduce your risk, but please consult with your advisor (or me) before taking action.

According to Andrew Thrasher, CMT, comparing the current S&P 500 index decline to past bear markets, there hasn’t been a time in history that a bear market has begun with such a severe and speedy decline. Not the Great Depression. Not Black Monday in 1987. But out of every bear market before this one, a new bull market was born. This one will be no different. Just be patient as there will be plenty of time to jump into the next bull market.

Meanwhile, I hope you'll stay safe and healthy during this health crisis. Take every precaution you can to keep your family and you as healthy as possible. Like every crisis before this one, this one too shall pass. If you have any questions, please don't hesitate to get in touch with me.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: InvesTech Research