Context in Markets 2/29/2020
Above is a chart of the S&P 500 going back to 2010. At 3,000, the S&P now trades at three times the price of it's 2010 low, and nearly 5x the 2009 lows.
Notice the simple line on the chart to give a sense of the uptrend the market has been in since. Don't call this technical analysis! I am not drawing arbitrary lines to make wild price predictions or calculations. I'm just showing the history of prices. This line shows the general speed at which the S&P has moved higher over a 10 year period. Notice how each time price went above the line sell orders came in and brought prices back in line with the longer term trend. Why am I pointing this out? Just over a week ago the S&P was trading further above its 10 year trend-line than ever before. Prices are not obligated to stay within a trend, but it is worth noting that stock prices were trading the highest in 10 years relative to the trend before the swift sell-off.
Then, while the market was making highs around 2/19, there was an increasing awareness that the numbers of Covid-19 cases in China were being understated, and that it was spreading. I for one remember being more shocked that stocks had not sold off sooner, than I am now that they did. Stocks were overbought on the short term, and there is increasing evidence that the risk (Covid-19) the markets more or less shrugged off, is a real. That is a bad scenario for stock prices in the short term.
One of the things about the Covid-19 that poses a challenge for pricing of assets in general is that it is unfamiliar and unpredictable. Aside from it's novelty, the implications are essentially impossible to calculate. Even if we knew for certain when the virus would be fully contained, predicting the response of individuals is a fool's errand. I for one watched myself change my mind on what activities I might and might not do rapidly in a 3 day period. If I can't figure out what I want, how can I venture to create a model for how 6 billion others' behavior might change?
A few times in the last week I thought about the Asian Contagion of 1997;
https://en.wikipedia.org/wiki/1997_Asian_financial_crisis
While I know nearly nothing of the specifics of the Asian Contagion, I remember the lesson that chain reactions can be set off from seemingly contained incidents. In the context of the Covid-19 scare, it is hardly unreasonable to worry that short term stagnation in commerce could lead to insolvency for some (governments/corporations). Companies with significant short term debt obligations could default setting off a chain reaction that could reverberate far beyond the companies themselves. We will see some companies whose most painful days may be ahead of them if supply chain disruptions lead to delinquencies debt payments. Personally I am wary of the energy sector, where producers with high debt obligations are facing declining prices amid global supply concerns.
Friday's price action was positive.
Some companies will certainly feel the pain more than others, but the broader indexes gave reason for hope. (3 year S&P 500 chart below)
The bounce off of the low yesterday occurred at 2850. 2800-2900 really served as the battle zone for S&P price since the beginning of 2018. It is generally encouraging when you see a level that served as resistance act as support when it tests that level from the upside. The size of the bounce (150 handles by end of day) is also encouraging for the bulls.
It is worth re-iterating that (notwithstanding dividends) at Friday's lows, S&P holders were EVEN over a 25 month period. While the August 2019-Feb 2020 rally may have gotten a bit ahead of itself, the last two years have not been a one way train. I think the 2019 returns on the S&P created a misconception of what has been going on in markets in the wider context. The S&P was up ~30% in 2019, but that is misleading performance. September 2018-end of Dec 2018 the S&P gave back 500+ handles (a similar sell-off to last week's, just spread out over months). The recovery from early Jan 2019 back to the levels of the Sep 2018 highs made up the bulk of the 2019 performance.
The absurd post financial crisis attitudes towards market volatility that have become the norm
I have recently read a number of posts about how this move is a sign that our markets aren't healthy. That is preposterous. The Post financial crisis investing public has been spoiled by a Fed/government that has been incredibly accomodative. Despite the fact that indexes are up multiples from where we were just a decade ago, a 5% pullback in markets is enough to get the pundits/politicians acting like its 2008 again. And I suppose why not. If people vote with their wallet in elections, why not sound the alarm bells every time it looks like your equity portfolio might take a hit? While I can understand "the why", the reasoning and excuses for this level of fear is unwarranted. Just because the fed has all but destroyed volatility in markets, does not mean that volatility is bad. Volatility in markets is healthy. This isn't the early 1900's where crashes were frequent and the extreme swings created challenges for the stability of business. This is a 10-15% correction that happened quickly in a market that had gotten ahead of itself and faced a major unknown that could disrupt global supply chains. Sell-offs are a part of any bull market, and nothing about last week's price action tells me markets are "unhealthy".
These markets are in fact much healthier than the 2011-2014 markets. While both markets have been the beneficiary of accomodative policy, the former saw far less volatility on a single stock level than the markets of today. Back then, QE/broader policy was a tide that allowed all boats (stocks). Today's market often brutally punishes stocks that miss earnings/ rewards those that beat expectations with double digit % returns. While (notwithstanding last week) volatility has been low at the index level, the volatility on the underlying stocks has been tremendous. I remember when people used to say commodities were not suitable for trading for most investors because of their volatility. Now, the FAANG names, TSLA etc are far more volatile than most metals/commodities. Traders need to know that at the single stock level there is plenty of risk, but from a market perspective, this is healthy.
Big picture for US equity investors
There is still money on the sidelines, and the rally from August to recent February highs took place amidst a backdrop of generally bearish market sentiment. Some have argued that the recent wipe-out was due in part to levered longs who were out of the market looking to catch up with performance (forced to liquidate accelerating the sell-off). It is worth keeping an eye on equity flows. If there are massive inflows to equities, it is wise to be aware of the increased risk that there will not be buyers to provide support on a down-move. When there is money on the sideline/bearish sentiment, longs can feel more comfortable knowing that if converted, those bears/sideline money can bring the demand needed to push prices higher. This may be what took place towards the recent peak... but as is commonplace... those converts get to the party just as it is about to end.
The one clear defining characteristic of the markets from 2009- now is an accomodative backdrop. I think it is safe to say that a friendly rate environment will persist at least until next year's elections. At the simplest level, this is good for equities because there is so little yield in bonds. If you want returns, there just aren't that many places to go. On the flip side, with rates this low, the fed's toolbox has shrunk. That puts investors at greater risk as even with the will of the people/fed to act, their tools may be too blunt to stop extended sell-offs and stimulate the economy. In that world, you can still be bullish equities, but reasonably expect more frequent sharp draw-downs along the way.
There are always unknown unknowns, like Covid-19 that change the entire investing picture. Unfortunately, aside from some insurance against extreme events, there isn't much we can do to predict. Even then, that insurance doesn't always work out (I thought I'd be selling gold at 1800, not 1580 this week). But if a business friendly/ accomodative Fed is the characteristic of this bull market, I would see anything that serves to disrupt that as the biggest knowable risk. Populism is on the rise globally, and thus predictability of election outcomes decreases (Brexit, Trump election were not accurately handicapped). While I would rather spend my time doing anything but watch political news, I will be keeping an eye on how the odds shift for Democratic nominee and ultimately the general election. As discussed previously, it doesn't take a lot for post 2009 stock owners to kick and scream with fear at the smallest sell-off. If there are any major shifts in expectations along the way about who will be president, I would expect to see markets to become more volatile.
Feel free to ping me if you'd like to discuss any of the above. Enjoy the weekend.
-Ben
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