The Crisis Takes a Different Turn
What a difference a few days can make for markets, especially with volatility so high. This week, the health crisis significantly worsened, and economic activity rapidly declined as a record number of jobless claims was reported yesterday. Yet in just three days - from Tuesday through Thursday - global stocks recovered nearly 20% from their lows, reacting to massive monetary and fiscal policy response.
Investors have a simple question: Were Monday’s market lows the bottom? The short answer is we don’t know, nor does anyone else.
A massive recovery rally is certainly welcome. After sinking more than 35% in just a few weeks, any relief was appreciated, and this rally was one for the records. It’s often under-appreciated that in a crisis, the stock market can’t recover until debt markets begin to heal. Last week the bond market was in disarray with wild gyrations and bids scarce for even the highest quality securities. The Federal Reserve’s unprecedented bond market intervention and aggressive monetary easing have calmed that market. Those actions coupled with promised extraordinary fiscal relief (unanimously passed in the Senate, but as this is written, still not passed by the House) have rapidly taken the worst of the possible economic scenarios off the table and the stock market responded in kind. But this is a health crisis that became an economic crisis and a financial crisis. The Fed moved to address the seizing up of debt markets and resulting concerns about the banking system. Congress moved to bridge the economic pause. But neither action addresses the health crisis. A massive effort to develop new therapeutics and a vaccine (with significant relaxing of the associated red tape) raise some promise of a potential medical response should the virus return again after this wave but may not impact the current outbreak. The health crisis mostly needs time.
Jay Powell, Chairman of the Federal Reserve, argues that the economy was quite strong before this crisis, and sees no reason it will not quickly recover once the health crisis passes. A former Fed Chair, Ben Bernanke, asserted that the economic impact of the crisis is more comparable to that of a very large natural disaster than to a traditional recession. Indeed, we have said that this economic decline will prove to be different from all others in that with this one we know what event will mark the beginning of economic recovery, and that is the much-anticipated Great Reopening (to appropriate a term from a friend). We don’t know when that will occur, but most expect it will be within weeks rather than months.
However, before that happens, the US “new case” curve will have to bend, climbing less steeply. And that has yet to occur.
We also previously noted that market bottoms generally follow volatility peaks by a bit. In this case, market volatility peaked (so far) on 3/18, so the market lows of 3/23 technically fit that pattern. Historically, the time between volatility peaks and market bottoms has on average been longer than that, but this bear market’s drop of 20% from prior peak occurred more rapidly than any other bear market, so it’s possible other aspects will be compressed in time too, we don’t know. But so far, while down from its highest levels, market volatility continues to remain remarkably high, giving us considerable pause.
We have previously said markets are mechanisms to “discount” the future and should be expected to turn up before the “all-clear” (or “mostly-clear”) is sounded and economic recovery begins. It’s also entirely possible that markets turn upward even before the new case “curve” bends. However, most market bottoms are not V-shaped, exhibiting instead a bit of back and forth churning to establish a bottom.
We cheer the market’s relief, but at this stage we remain skeptical that market pain is fully behind us.
So, how do we respond to such uncertainty? Longer term, we understand that markets are cheaper now than they were before the bear market, and cheaper than they are likely to be a year or two from now, so we are actively rebalancing. Today, that means selling bonds and buying stocks. But given that market volatility remains so high and that the volatility peak was so recent, we are for now tempering that rebalancing and buying only part of the amounts of stock needed to bring each account’s asset allocation back to targets.
Whether that caution will prove to be beneficial or not is unknowable now. But what we do know now is that this crisis will be temporary. It will end. That is the fundamental nature of every pandemic throughout all history. Hang in there. We’ll get through this crisis too.