"V", "U" or Checkmark?
Congratulations, you made it through an even worse day in the stock market than last Thursday. This is some roller coaster. Not even during the Global Financial Crisis of 2008 (henceforth called “GFC”) did we have down 10%, up 10%, down 10% like this. This is truly unprecedented.
What happened? Friday’s big up day was a bit of a mirage with 1000 points gained in the last 25 minutes of trading. It was a classic “short squeeze” so today’s action wasn’t completely unexpected. All told, we’re about 2% lower than last Thursday’s rout.
Two weeks ago, markets were anticipating a “V” recovery. That is, the pain would be short-lived and things would recover in a quarter or two, forming a V-shape. A week ago the market realized it was more like an elongated “U” and would probably last a bit longer. Today, the President let it slip that things may not be under control until July or August. The market had started to price this scenario in all day until he unexpectedly acknowledged it. Markets are now in the process of pricing in more of checkmark shape with a longer, slower recovery.
Indeed, unless there is a vaccine available in a miraculous amount of time, it is highly likely that social distancing and anti-social behavior are here to stay well into next year. The shutdowns we are currently experiencing will cause a sharp, painful economic contraction. If it blunts the viral spread, we’ll be resuming some public behavior but it is likely to be subdued for a long time. That is, it will be at least a year before anyone spends time in a crowded place. The survival of our service economy depends on finding ways to mute these economic impacts. Take your local gym, for instance. They close as per the Governor’s instructions but what of paying its employees? Just as significant is how long can the gym owner keep paying the owner of the commercial property where the space is leased? In turn, how long will the owner of the entire strip mall be able to pay its debt financing? This cycle, left unchecked, is just as serious as the GFC.
A number of you contacted me and wisely said “when do we buy? Let’s not miss this opportunity.” I agree, almost. As mentioned last week, it’s time to nibble on some stocks but not too much. Fighting the economic effects of social distancing is difficult. Frankly, it is a very difficult problem. Think of the gym owner again. How will the government provide support? On what would they base compensation? Would it be a loan or outright payment? What sort of proof of need is required? Must a business apply and what is the process? Can a solution be delivered before anyone misses a payment or goes bust?
Until some decent idea of the answers emerge, markets are going to suffer without seeing the light at the end of the tunnel. During the GFC, the answers were pretty obvious but moral hazard and politics got in the way. Business cannot be blamed for the virus- no one did anything wrong- so politics is probably less of a hurdle than finding workable solutions. With that in mind, we may see significantly more downside. Conversely, a few consecutive days of progress could see markets rally 15%. In sum, I’m generally a seller of rallies, while the lower stocks fall, more aggressive I’d be inclined to buy. I do not think we’re in danger of missing an opportunity yet. Remember, markets overreact in both directions- we started with a wildly expensive market and it may eventually pass into an overly cheap one. Right now, we’re in no man’s land between average and expensive.
In other news, there appears to be a little bit of distress in the commercial paper markets. Commercial paper is the very short-term, high quality bonds that business issue to fund operations and is of importance because it is owned by money market funds. We will likely reduce our holdings and switch to funds which hold only Treasury obligations. This is not because I am worried about the safety of money market funds, but rather after the Fed’s emergency lowering of rates to zero last night, all money market funds will yield almost zero within about six weeks. That makes owning them largely unnecessary for now.
Please call anytime- always happy to talk about this with you.
Keep calm and stay home, Brett