Market Commentary Q1 2020

By: Matt Garrott

What Happened this Quarter

The year in headlines started with the death of an Iranian General.  Concerns that this would start World War III fizzled and the markets shrugged their shoulders as even oil markets barely flinched.  Stories started circulating in January about a virus in China.  The United States was consumed with impeachment, confusion over the Iowa caucus, and the idea that Bernie Sanders was the frontrunner to win the Democratic primary.  The coronavirus shut down China, setting off ripples throughout the global supply chain.  On top of that, Russia and Saudi Arabia bottomed out oil prices over a disagreement in production.  Volatility roiled the US stock markets, setting off circuit breakers on multiple days.  COVID-19 spread across Europe and finally the United States.  Individual states have responded with quarantines and the nation has mobilized to support the healthcare system.  The press got their World War III – the enemy is a virus.

The S&P 500 peaked on February 19th.  By March 23rd, the S&P 500 was down 33.8% from the high.  This was the fastest bear market ever.  It then rallied 17.6% with the Dow Jones Industrial Average rallying over 20%.  In total, the S&P 500 is down 19.6% this quarter.  The market has made up some ground since the bottom, but high levels of volatility indicate that the bear may not be done.  The average absolute daily market move in March was 5%.  The historical average is about 0.70%.

There was also a brief race for liquidity in the fixed income markets.  Seasonality of raising cash for tax payments combined with rebalancing trades accounted for some of the rush, but massive selling of high yield debt put money managers in a crunch.  They were forced to not only sell their high yield debt at unfavorable prices, but they also had to sell their higher-quality bonds to keep up with redemptions.  The Federal Reserve stepped in and provided several avenues for liquidity for the markets.  Trading, while still not great for sellers of high yield, is orderly again.

Welcome to a Bear Market

It’s been over a decade since the bottom of the financial crisis in 2009.  Going so long without a bear market is unlikely, but nobody expected it to happen so soon.  The near-bear market in the 4th quarter of 2018 lasted 95 days.  It took 109 days for the S&P 500 to recover.  The 33.8% drop from the peak this year only took 33 days, but it has felt so much longer.

JP Morgan’s Chief Global Strategist, Dr. David Kelly, is fond of saying that the markets are like Florida’s seasons – long summers and short winters.  Indeed, looking back at previous bear markets (using daily price returns of the S&P 500 – not counting dividends), they are often short and violent.  1987’s 34% drop lasted 99 days, but was followed by a 4,430-day bull market that gained 582%.  The bursting of the Tech Bubble sent the S&P 500 down 49% and lasted 915 days.  The ensuing bull market rallied “only” 102% over the next 1,800 days.  Stocks fell 57% during the 510-day Financial Crisis.  Our most recent bull market gained 378% over 3,892 days.  Over the last 80 years, the average bear market fell 39% and lasted 505 days.  The average bull gained 220% and ran for 2,267 days.

Crystal Ball

Who actually saw this coming?  No one.  Even if you knew the news in advance, there are days like March 26th where the US overtook China on infections confirmed by Johns Hopkins AND weekly unemployment claims went vertical to 3.3 million. What would you have done, knowing these two massively depressing headlines in advance?  Would you expect the market to gain over 6% that day?  Even with perfect information, it’s difficult to predict what the market will do, especially over short time periods.

Prudent investors recognize that following their financial plan isn’t just for when it’s convenient.  It prepares them for downturns, too.  Proper planning ensures that sufficient cash reserves are maintained so investors are never forced to sell anything to meet near-term cash flow needs.  Rebalancing and harvesting losses are two ways to exercise real control over the situation.  There is an old saying that in bear markets, stocks return to their rightful owners.

Final Notes

The human loss from the pandemic is already being felt.  The impact to the US economy is real and deep, but it is also temporary.  More so than past bear markets, there is a clear end in sight.  Whether COVID-19 fizzles out, we develop anti-viral medications, or a vaccine is developed, the pandemic is being managed and it is beatable as we are already seeing in countries like South Korea.

We try not to lose sight of the advantages we have today.  We are fortunate to have the internet and the particular flexibility it affords us during quarantine.  We’re also seeing how important physical grocery stores, pharmacies, and the local Greek restaurant (shoutout to Taki’s in Avon Lake) are.  This situation is certainly unpleasant, but a combination of recent technology and brick and mortar have made society surprisingly resilient.

Fairway Scorecard 3-31-2020