It’s uncomfortable to comment on markets and money at a time of such suffering. We don’t write anything intended to diminish the tragedy of that suffering, and yet we must largely address other issues.
Several weeks ago, when we began to share weekly market comments with plans to do so for the duration of the crisis, we realized there would likely be some weeks before it was over in which little changed, and we might have little new to say. That was not the case this week.
In this shortened market week that included both part of Passover and the lead up to Easter, stocks posted their largest weekly percentage gain in 46 years. Congress’ “Payroll Protection” forgivable loan program for small businesses fitfully opened last Friday but broadened this week. Yesterday, the Federal Reserve unveiled another massive and unprecedented liquidity program, this one aimed at “Main St.” (businesses with up to 10,000 employees) and state and local governments. Oil prices initially rose on reports the Saudis and the Russians declared a truce in their ill-timed oil production war in the face of greatly diminished demand. Markets cheered.
But this is foremost a health crisis and that storm rages. New cases and deaths mount at alarming rates, yet public health leaders point to encouraging signs. Much of Europe appears to have turned a corner with fewer new cases and deaths, although progress is uneven across countries, and the US is thought to be generally a week or two behind Europe. The New York area, epicenter of the virus here, has seen a decrease in new cases, although total active cases continue to grow. While deaths continue to rise there, they too are expected to diminish soon. Although growth in total new cases in the US is slowing, like Europe, we have some areas where cases are climbing rapidly at the same time as other areas appear to have successfully “flattened the curve”.
We’ve previously noted that the market was looking for an inflection point in the health data, the point when new cases would peak in many places and total active cases, with a lag, would stop rising and turn down as well. It appears we may be near the peak in new cases now.
The key questions now become: Can states and countries find a pathway to normal economic activity without reigniting the spread of the virus; and how quickly might that transition arrive. It’s possible getting there may require a big ramp up in testing (both for COVID-19 and for antibodies) and much shorter turn-around times. The nation is on a war footing with medical research being our modern-day Manhattan Project. Progress on that front could significantly change the trajectory of this crisis, but the scale and timing of that impact is unknowable. Significant uncertainties also exist about the lag time between the inflection point for the pandemic and the lifting of shelter in place orders which is when the economy should begin to recover.
Thursday, Jay Powell, Chairman of the Federal Reserve said, “there is every reason to believe that the economic rebound, when it comes, will be robust” and he added, “one thing I don’t worry about is inflation today.” We have noted that employment was quite strong before this necessary shutdown, and we see no reason we will not experience a strong recovery from this self-imposed recession after this health crisis is behind us. But it is increasingly likely that the lifting of restrictions will not occur in all areas or even for all people at the same time. In that event, even a strong recovery that begins in stages will take a while to get going.
The point is that there are significant uncertainties on the medical front, including when new cases significantly diminish, when treatments and vaccines arrive, and when broader and faster testing becomes available. There are substantial uncertainties about how long it will be between the turn down in new cases and the lifting of the restrictions that will allow the beginning of economic recovery. There are also material uncertainties about how long a staged restarting of the economy may take, and whether it can be done without triggering a resurgence of cases. Investing always occurs amidst uncertainty, but our sense is that these uncertainties loom larger than normal at this juncture.
Greater than normal uncertainty is OK if adequately reflected in valuations. That’s another way of saying that greater than average risk is OK if expected returns from this point fully compensate for that. But after a partial, but sharp recovery in stocks over the past three weeks, the Russell 3000 index of the broad US stock market sits only 15% below where it was at the end of the year. That is remarkably near its level just over three months ago, when none of these uncertainties and threats to the economy were imagined. On the other hand, with this extreme volatility, there are substantial differences between year to date returns across market sectors and stocks, and many individual stocks remain much cheaper than one might assume from that relatively modest overall market decline, so select opportunities exist even if broad opportunity has diminished.
We’ve also written of elevated market volatility, and while that has improved somewhat, it remains high. The most common gauge of stock market volatility is called the VIX Index. Having eased to about half of its peak just over three weeks ago, that index remains more than twice as elevated as its average level over its full life of over 29 years. Volatility has certainly improved, but not sufficiently to fully remove that caution.
Markets are discounting mechanisms, reflecting the changing outlook for future developments before the news arrives. So, a market bounce from the extreme pessimism of a few weeks ago should not be considered unusual, even if its speed and strength have been. We welcome this positive turn in sentiment, but we caution that improvements in the health data and in the outlook for when the restrictions may begin to be lifted may be more uneven.
We take the long view, and this will pass. But elevated volatility seems unlikely to disappear in the short term.