"Don't Panic, there will be plenty of time for that later."
-Gregg Easterbrook
Sometimes I struggle for what to write in this newsletter month by month, but not this time. The recent market gyrations, mostly sell-offs but with some notable rallies in between, are a cause for concern. I sent out two emails to our clients during the week of February 24
th, both written by Brad McMillian of Commonwealth. As you know, anything I write has to be compliance approved and as wonderful and prompt as those professionals are, it still takes a few days to get approval and the immediacy of the issue seemed to merit a quicker response. Now that we’ve had a little time to digest let’s talk about the markets, Covid-19, and whether these sell-offs are because of the Corona virus or just triggered by them.
The Markets
Let’s put these sell-offs into perspective. Yes, 1,000 points seems like a crazy amount for the Dow to go up or down in a day, and yet it has moved by that number five times in the last eleven trading days, as of this writing. But points don’t really matter, what matters are percentages. In the famous Black Monday stock market crash of October 19, 1987, the Dow sold off 508 points in one day – a pretty mild day as of late – but that represented a 23% downturn based on the Dow’s total point value 33 years ago. For the market to have a similar sell off it would have to drop almost 6,500 points. CNBC doesn’t have loud enough graphics for a 6500 point sell off! So far, the markets at their worst have sold off about the same amount as they did in the fourth quarter of 2018 – a whole year and a half ago – and in between we had a great year. In fact, all these sell-offs have done is put us back to where we were in October of 2019 – and if last year had ended three months short it still would have been a great year.
With that said, the markets were overvalued regardless of the Corona Virus. I’ve been saying that in these articles for months now. The low returns on most other assets; bonds, CD’s, bank accounts etc. have driven people into the stock market who normally wouldn’t be there, pushing stock prices higher than the underlying earnings of companies probably merit. This also means that a lot more risk adverse people and shorter-term money is in the markets than should be – so when a sell off starts to happen the reaction is swifter than when the market is mostly populated by long-term and high-risk investors. On the plus side, a sell-off like this also allows for a reallocation toward better businesses. With the rise of indexing a huge percentage of the investing public put their money into “the market” rather than choosing individual companies. This means that during a rising market, less well-run enterprises are seeing their stock prices increase along with the better managed, better capitalized companies. Conversely, when the panicky people sell those same index investments the well-run companies get hit at the same rate as the poorly run, meaning there are bargains to be had. In a portfolio that tilts toward better capitalized, more profitable companies there is very little to be gained during an uninterrupted upswing, but when we have a market shake-out like this those companies have traditionally outperformed in the weeks and months to come.
The Virus
I don’t want to say the worry about Covid-19 is unfounded and overwrought, both because I’m superstitious and because real people have actually died of this thing so it’s not a laughing matter. But it is possible that the media has hyped the risk of physical danger to the average person beyond what is warranted by the evidence. Scenes of people buying CVS out of surgical masks (which won’t protect you) and Costco out of hand sanitizer (which will protect you but not as well as washing your hands) remind me of the annual Black Friday broadcasts of people trampling over their fellow man to get a plastic toy. Moreover, it’s going to appear to get much, much worse even if it’s only getting mildly worse, or even getting better. The U.S. just started testing the broader population for this disease, up to now they were only testing those who had traveled to areas with a large concentration of confirmed cases. There could already be tens of thousands of people in the United States with Covid-19, most of them – like in China- with very mild symptoms. Confirmation of that fact does not equal a spread of the disease, just a spread of test results. On top of that, the news of Covid-19 is going to drive people with very mild symptoms who otherwise wouldn’t have sought out medical attention to go see their doctors or report to emergency rooms – which will also increase the numbers of known cases.
The experience so far in China has been a sharp increase in the number of confirmed cases – corresponding with the onset of wider testing, peaking on January 31
st and then the number of new cases slowed dramatically. China’s response to the spread of the disease was fairly dramatic, they banned travel to and from the Wuhan area, they closed schools, factories and businesses and they quarantined perhaps hundreds of thousands of people. In Japan, South Korea and Europe they have likewise changed plans to slow or stop the spread of Covid-19. There have been soccer matches played in empty stadiums, The Louvre closed, large gatherings and festivals have been postponed. The Paris marathon was just cancelled and there is talk about postponing the Summer Olympics scheduled to begin in August in Tokyo, Japan. Most of these actions have been taken “out of an abundance of caution” to use what is quickly becoming 2020’s catch phrase. How far the U.S. goes will be somewhat determined by the test results over the next week or so, but we may see more of the same here. Regardless, each individual person’s risk of infection is very low especially if you wash your hands regularly and stay away from large crowds in confined spaces as much as possible.
The Economic Impact
There are actual economic impacts being felt by the global response to the virus. Trade out of China slowed dramatically, meaning supply chains that rely on Chinese products have been disrupted. Beyond trade, travel related industries; airlines, hotels, rental cars, ride shares, amusement parks, oil companies are directly affected by lower sales. Those empty soccer stadiums don’t hurt TV ratings, but just think of what big public events produce for local economies: Food and beverage vendors, clothing sales, security personnel, custodial staff, delivery people etc. That economic activity is being put on hold. Some estimates are that global growth for the first quarter of this year will be cut in half. It’s understandable the markets would react to those factors, considering that ultimately market prices are supposed to reflect corporate earnings in some respect. In response to this risk, the Federal Reserve cut interest rates by a full 0.50 percent. I personally think this was somewhat of a panic move and only made things worse in the short-term. When the Fed acts quickly like this it can be interpreted two different ways. During the financial crisis of 2008, since the issue was liquidity and the Fed is the last resort for keeping the markets liquid, the massive rate cutting was seen as a good thing. In a time like this, when the full extent of the Coronavirus on the economy is really not known, the Fed cut made people worry that it’s going to be worse than they thought. But it does create some opportunities we’ll discuss in a moment.
But stock markets aside, I wouldn’t worry too much unless you start to see more dramatic economic contraction. The February Jobs report just came out the morning of this writing and it blew away the estimates on the plus side. At the same time, because of these slow downs in certain areas and the cost of some staple products – especially oil and gas – have dropped dramatically which puts more money into the pockets of the average person. Unless we see actual empty store shelves (with the exception of the jerks buying all the hand-sanitizer) and layoffs exceeding new hires I think we’ll stay out of recession and just be dealing with a market correction.
What should you do?
If your portfolio is positioned correctly with short-term money in short-term investments and long-term money in long-term investments then right now you should probably do nothing. If you have money on the sidelines that should be invested you might want to take advantage of lower prices to establish a market position. The funny thing about stocks is, they are the only thing people don’t want to buy on sale. When the price is high everyone wants in, and when it goes lower everybody wants out. Think of equities the way you think of anything else you purchase; you should buy them when they're on sale. Automatic re-balancing of portfolios does this for you and it's why over time a less risky, but regularly re-balanced portfolio can perform just as well as the market itself.
Secondly, refinance everything. With the worry over the virus driving people into U.S. Treasury bonds along with the Fed rate cut, interest rates are reaching levels never before dreamed of. If you have debt, try to refinance it at lower levels. Don’t extend your term, don’t cash equity out of your house, don’t borrow more money – but if you can lower your payments or shorten your terms by refinancing your current debt load at a lower rate by all means do it.
Lastly, if you have money you want to be principle protected pay close attention. If you are lucky enough to be locked into a higher rate (which if you put that money anywhere in the past you are likely to be) then sit tight and be thankful you’re getting 1.5%. If you have money coming due soon or money that gets a revolving interest rate you may want to consider some out of the box solutions if you don’t need to touch that money for at least a year – ideally longer. I’m not talking about the rent money, or the emergency money, but that money you know should have been in the market for the last few years but every time you’re about to throw it in we get a December of 2018 13% selloff or a Covid-19 meltdown and you leave it in the bank. There are interesting alternatives to traditional fixed income investments and given that every time we think rates are going to spring back up to a reasonable level, they fall even lower, it may be time to consider other options.
My plan for this month was to write about the Secure Act, the end of the IRA stretch and some ways to mitigate that loss – but events seem to get in the way. Maybe we can revisit that exciting topic next month. In the meantime, if you are worried or just want to hash out what these market movements mean for you – and you’re a client- please give me a call. If you’re not a client, but wish you had somebody to hash out what these market movements mean for you – or your current adviser hasn’t addressed this market with you in any manner – give us a call.
