A Crisis of Confidence

A brief preface: while my focus is on the financial impacts of the coronavirus, I absolutely recognize that this is a humanitarian crisis. Please stay safe and smart, and pray for the vulnerable as we navigate this catastrophe together.

Where things stand

The stock market suffered another sharp drop today, pushing all of the major indices into "bear market" territory, meaning they are all down more than 20% from the recent record highs.

My take

We're in the worst phase of this cycle: we have a clearly identified problem, but no cohesive strategy for addressing it. During times like this, anxiety is high, and confidence is low. To me, it feels much like the immediate aftermath of the terrorist attacks on Sept 11, 2001, when fear was widespread but a vision of solutions was not yet formulated. We knew the threat, but for a period we were unsure how we would navigate the drastically changed world.

This is a time when we need our leaders to acknowledge the challenge (both the public health and the economic challenge) and instill confidence that they are taking steps to mitigate the damage and lead us through this crisis. Just looking at the market reaction today makes clear that the message delivered last night by the President did not accomplish that. 

And if you need further confirmation, look at the odds for the winner of the Presidential election: Joe Biden as of today is the odds on favorite. One month ago Trump was a heavy favorite.

This is not a financial crisis like 2008, this has morphed from a health crisis to a crisis of confidence. Until confidence is restored, buyers of stocks will be scarce, and volatility will prevail.

Ultimately, the virus spread will slow, we'll get closer to developing a vaccine, and measures being taken on local and state levels will work as they have in other countries who were affected earlier than the US.

But how much damage is done to the American psyche, the economy, and the markets in the interim is largely a function of how well our leaders lead.

Looking ahead

In my 32 years in this business  I've been through many corrections and nasty bear markets--Long Term Capital in 1998, the Dot Com implosion in 2000, 9/11 in 2001, and the Financial Crisis in 2008 just to name a few. One of the key characteristics successful long term investors have is their ability to separate themselves from the headlines and take a broader, longer view of the landscape.

In addition to following the news and markets and communicating with you, I've been spending a lot of time looking at the opportunities that have developed in this sharp sell off. While I would not recommend acting until the issue of confidence has been resolved, there are incredible opportunities already present in markets today. 

For example, in sell offs like this, everything gets sold, good and bad. There are countless blue chip companies not directly impacted by the virus whose shares have declined 25-30% in a matter of weeks. With bond yields currently in the 1-2% range, buying a basket of such companies with dividend yields of 3-5% makes a ton of sense for long term investors.

There will be phenomenal opportunities to invest cash and re-position existing investments, and when that time comes I will absolutely let you know.

When will markets bottom?

It's nearly impossible to know when markets bottom, but here are the three things I'm watching for

• A PLAN: The Federal government announces a comprehensive plan on both the heath and financial fronts to address the coronavirus: increased testing, more thought-out steps to slow the spread, financial support for employees and businesses through payroll tax relief and supplementing lost wages, and continued liquidity like the Fed announced today. If I were a betting man I'd say there's a good chance we'll have an announcement before this Sunday night.
• A REVERSAL: A day where the markets start horribly and rally to end positive. This would signal that prices have finally reached a point where there's so much value that investors will step in regardless of the uncertainties. Again, if I had to put a time frame on this I'd say before the end of this month.
• A DECLINE IN NEW CASES: While most experts believe this virus will be with us at least until Summer, markets will look for the spread to show signs of slowing. Markets are likely to bottom well before this virus goes away, and smart money will be watching the daily reports on new cases. Maybe we see this in late May- early June?

Finally, I'd like to share a chart from one of the countless pieces of research I've read over the past weeks. This chart from Goldman Sachs shows the magnitude, length, and recovery time of past bear markets broken down by type: structural (ex. Financial Crisis), cyclical (normal recession), and event driven (ex. Gulf War). The coronavirus is an event driven bear market.

In general, event driven bear markets tend to be shorter and shallower than most. It's possible that this episode follows past event driven sell offs, but clearly there is a difference in how various bear markets tends to act.

As I have done throughout this period I will continue to share with you in these messages not only my thoughts but also the thoughts of a wide variety of economists and market strategists as events unfold.

And I will continue to reach out to you proactively in the coming days and weeks just to check in.

In the meantime, please don't hesitate to reach out to me if you'd like to discuss this in detail or look at your plan and portfolio.

Sincerely,

Kevin