Jason Blackwell, CFA, CAIA®
Chief Investment Strategist
March 13, 2020
At The Colony Group, we take a long-term perspective despite a shorter-term news cycle. During this period of higher uncertainty, we aim to provide more frequent market updates and give perspective on how the news of the day impacts longer-term expectations. With markets reacting to news breaking moment-by-moment, what we write this morning will be old news by this afternoon. Even so, as Colony’s Investment Team, we want to keep you apprised of what’s happening and do our best to provide as much clarity as possible as events continue to unfold.
This was another volatile week; unlike last week, however, this one will stay in the history books. From Monday through Thursday, the S&P 500 Index fell by over 16% before earning back 9.3% on Friday. On Thursday alone, the Dow Jones suffered its biggest one-day drop since 1987. The volatility of equities reflected the panic that is ensuing as a result of the spread of COVID-19. Investors are uncertain and, we believe, selling in panic. The uncertainty is warranted, but the panic is not.
Just a few weeks ago, we outlined several possibilities concerning containment efforts and the associated impacts in February Market Update: Coronavirus And The Markets. At the time, we suggested that a “mass containment effort” scenario was the least likely initially and suggested that our base case was for low (but not negative) growth over the first half of 2020 with the potential for a rebound in the second half.
In the past week, we saw a shift by local and state governments toward the more widespread containment effort. Festivals, concerts, even sporting events are being cancelled en masse. Universities and K-12 schools are closing. Even Disneyland is closed. On a national level, the President ordered travel restrictions from the European Union. These moves further reduced our expectations for economic growth, or more accurately, increased expectations for economic decline. That has consequences, and the markets are reacting harshly.
This week, on top of the shift toward the more widespread containment effort, tensions within the OPEC+ countries threw gas on the fire. After Russia, an ally of OPEC, walked away from negotiations to limit oil production amid a global decline in demand, Saudi Arabia decided to take advantage by announcing increases in their production and offered reduced pricing on their oil to take market share. On Monday, oil prices declined by 30%.
As the week wore on, expectations built for additional fiscal stimulus. On Wednesday night, President Trump addressed the nation and put forth several proposals but none of which were “bold” enough to satisfy investors. He followed up on Friday afternoon with a more aggressive stance declaring a national emergency (which frees up as much as $50 billion of aid to states and territories), announced a waiver of student loan interest, and announced that the US would be buying oil to fill up the strategic reserve (and soak up some of the excess supply). As Congress and the Administration work towards broader deals, the issue will likely be politicized. Our expectation is that policymakers will be able to put the economy and welfare of our citizens ahead of partisanship and find a meaningful and workable solution. When this happens, markets may adjust swiftly.
The Federal Reserve has taken actions (and will likely take more) to limit the impact on the economy. To be clear, the Fed cannot cure the virus and cannot fix supply chain issues. It can, however, keep the financial system liquid and reduce the costs of doing business. On Thursday, it announced a $1.5 trillion balance sheet expansion program to provide liquidity to banks who can, in turn, provide financing to businesses and individuals who have short-term cash problems. It’s further expected that the Fed will reduce target interest rates—perhaps to zero.
There is increasing talk that our economy may fall into recession. Based on history, investors should not panic over a recession. Since 1945, recessions have lasted from as short as 6 months (1980) to as long as 18 months (2007-2009), with an average lasting 11 months. The average peak-to-trough decline of the S&P 500 during recessions was -24.8% (notably, we are already past this level.) History also tells us that stock market recoveries begin, on average, about halfway through a recession, and in many cases, much sooner. The average return during the second half of a recession is 24.2%.
Markets trade on expectations rather than current conditions. Expectations move much more swiftly than economic data. While we do not know whether the economic hit will last 4, 6, 11, or 18 months, we do know that, historically, it has been better to be “early” rather than “late” to a market recovery. While the short-term outlook remains uncertain, we remind our clients that diversified portfolios and well-thought out financial plans are designed for these types of “market shocks” whether it becomes a recession or not.
As equities have fallen, other areas of portfolios, like fixed income and alternatives, have been more stable or have been increasing. Part of a well-disciplined investment plan is re-balancing portfolios and having a willingness to take advantage of panic selling. For this reason, we recommend investors work with their advisors and consider rebalancing and re-risking their portfolios – gradually. Especially during these volatile times, we believe it’s important to remain focused on the long-term.