Perhaps a positive spin to describe what we experienced in first quarter of 2020 is that it was “character building.” Aside from disruption to our routines of everyday life, we have lived through the worst first quarter on record in the U.S. investment markets.
Uncertainty breeds instability in markets. With the global economy in a government induced coma, we have endured the fastest and hardest roller coaster ride in market history, as measured by the VIX volatility index. Day by day, the market produced record moves down and up as investors frantically sought to predict how the crisis would impact the economy and businesses.
The pandemic is described by economists as a “black swan.” Black swans are events which are exceptionally rare in occurrence and severe in impact (examples: wars, pandemics, institutional failures). These historical events will force individuals, businesses and governments to change and adapt. The last major black swan event we experienced together was 9/11. Who would have predicted before that event that we would one day be required to remove our shoes to get through security at an airport?
It is encouraging to witness the resilience and ingenuity being demonstrated already by so many in response to the crisis – healthcare workers, teachers, parents, small business owners, and even governments have responded quickly and creatively to the challenges.
This pandemic eventually will pass, and the underlying fundamentals of the U.S. economy remain strong. Resilience and ingenuity are part of the DNA that make up America. We will persevere and we will recover.
In the meantime, the most important thing you can do as an investor is be patient and avoid emotion based decision making. Remember the words of wisdom from Warren Buffet:
“The stock market is a device for transferring money from the patient to the impatient.”
Today’s Economic Perspective
The coronavirus (COVID-19) has radically changed the global economic outlook. The U.S. has gone from a full-employment economy to something that can be compared to the devastation wrought by the Great Depression within a matter of weeks. The emergence of the virus has caused financial markets to plunge
almost everywhere as the global pandemic spread rapidly across much of the world.
This crisis is both unusual and unprecedented. The economic shock from the pandemic hit both the demand and the supply side of the economy, which is what makes it so unusual.
The demand side of the economy suffers when money is tight or spending is down. The government has a number of tools it can use to stimulate more spending (decrease taxes for example). The supply side, where products or services are unavailable or in short supply, is less common and can be more challenging to address. The gas shortage of 1973 and 1974 is a good example of a supply side shock to the economy.
Fortunately, a massive response from the Federal government and the Federal Reserve is underway, fueling some modest rebound and calming panicked markets. State governments will be tasked with striking the delicate balance between controlling the outbreak and gradually lifting restrictions on economic activity.
There is every reason to believe that the U.S. will be back at or near the record- low unemployment when people are once again allowed to return to work and leave their homes to shop. To slow the bleeding, America’s central bank is pouring more than $3 trillion worth of loans and asset purchases into the U.S. financial system—an unprecedented commitment. The newly-passed CARES aid package is worth an aggregate $2.2 trillion more.
A shock of this scale will create a shift in the preferences and expectations of individuals as citizens, as employees, and as consumers. These shifts and their impact on how we live, how we work, and how we use technology will emerge more clearly over the coming weeks and months. Institutions that reinvent themselves to make the most of better insight and foresight, as preferences evolve, will disproportionally succeed.
Today’s Market Perspective
The arc of global financial markets during the first quarter of 2020 corresponded with the unfolding realization that controlling the outbreak would require government-mandated shutdowns of “non-essential” activity — impacting large cross-sections of the world economy.
You don’t have to ask why Wall Street traders abandoned stocks in near panic mode. The coronavirus epidemic, social distancing and the closure of home offices, malls, theaters and anywhere else where people once gathered to work has raised uncertainty about the extent of business disruption in the U.S. and world economies.
A dash for cash by investors concerned about the economic fallout created disorderly conditions across capital markets. Major developed government-bond rates plummeted to multi-year and all-time lows as demand spiked for fixed-income securities regardless of credit quality, maturity, or other risk characteristics.
Quick action by the Federal Reserve appears to have helped reroute markets back toward orderly function.
During the quarter, U.S. stocks climbed to all-time highs before registering one of the fastest descents in history, triggering multiple exchange-wide circuit breakers that forced market closures for short periods of time during March. The CBOE Volatility Index (VIX) set an all-time high in mid-March, surpassing its high from the fall of 2008. The volatility cut in both directions as U.S. stocks earned their best three-day winning streak in more than 80 years during late March amid growing support for Congressional action.
Looking back a historical bear market characteristics can perhaps help formulate some reasonable expectations about what the future might hold for investors:
- A bear market is when losses exceed 20%
- The average historical drop in stock prices from peak to the bottom is about 35% (on March 23rd the market had dropped by 34%)
- Recovery time: 18 – 36 months is a reasonable expectation based on history
Market risk is greatly reduced with time, and this is one of the key principals that drives our planning process.
This year so far has been a discomforting reminder of what it means to be an investor. Intellectually, we all know that wise investing requires carefully balancing risk and reward over the long term. But in recent years it’s been easy to forget about the risk side of the equation. We’ve come to expect long-term, stable, growth, and we fear any loss of those gains.
Enduring instability in equities (like that of the last quarter) is the price we pay for enjoying returns that, over long time horizons, are likely to be substantially higher than those for cash or bonds.
Just like in 2007-2009, we have to believe in the resilience of capitalism to weather yet another “once in a century” storm, and in the value of persistence while many investors are making decisions out of panic.
Part of our mission is to help make sure you don’t turn a temporary paper loss into a permanent loss.
The pro-active approach to market volatility employed by Harvest Asset Group, which typically isolates a number of years of anticipated needs in safe reserves, means that short term goals can be funded without having to sell assets currently under pressure. This can help ease the emotional and practical difficulties of sticking to your investment strategy during periods of market distress like this.
There are times when we all face challenges more important than the ups and downs of the markets, and this time certainly qualifies. Staying safe, staying well, staying alive and keeping our loved ones out of harm’s way takes priority in this global pandemic.