Panic Sets In – But Should it?
Given what’s going on in the market this morning, I wanted to send some thoughts outside of my normal weekly email. Soon after the open, the Dow declined over 2,000 points triggering an automatic 15-minute halt in trading. Trading halts are in place to attempt to break the downward snowball effect and the first halts kicks in at a 7% decline from the prior day’s close. The market has ‘rallied’ since trading resumed and the Dow is now down just under 1,500 points. We continue to hold more cash than normal and I’m happy with that position. I’m not yet ready to start buying into this market and plan to take a conservative approach when reinvesting cash. There’s a lot going on and I wanted to work through the main ones.
It’s important to look back at where we’ve come from and what happened in the last market sell-off. Interestingly, today is the 11-year anniversary of the market low in 2009 following the financial crisis. The Dow closed at 6,547 that day. Today, the Dow is over 24,000. Late in 2018, the Dow declined over 17% from the prior high to an intraday low of 21,713 on December 26th. From there, stocks rallied over the next 14 month, reaching almost 30,000 just a few weeks ago. We are currently sitting at 24,469. We’re still 13% above the lows hit in the 2018, but we have given up essentially a year’s worth of gains in the past 2.5 weeks. This market is scared and confused. I don’t know where it will go, but testing the 2018 lows seems possible.
Big picture, this move is starting to feel overdone relative to the true risks in the market. That said, we still don’t understand the true ramifications of coronavirus, so while I believe this is a temporary situation that we’ll work through, it’s unclear how long this will take. While the problem remains very small in the US, and even in the world when you look at absolute numbers, the potential for this to significantly slow economic activity is pushing stocks lower. The number of cases continue to increase. The critical unknown is how many patients are truly infected. A higher number of undiagnosed cases means the death rate is much lower than being reported. Testing appears to be ramping up with Labcorp and Quest Diagnostics announcing over the last few days they can now process tests. Getting a handle on how many people have the virus would go a long way to calming the markets.
Oil is down almost 20% today and roughly 50% over the last two months. Oil notoriously ends up oversold or overbought and this feels like that. Part of today’s drop is OPEC’s failure to meet a production agreement, meaning oil producing countries could increase production to try and increase their market share. This failed agreement comes at a time when global demand is already dropping, making the matter worse. The drop in oil is pushing oil stocks lower and raising further concerns about global growth in the near-term. Oil under $40 is good for consumers, but it’s not great for the overall economy. Oil exploration and drilling employee a lot of Americans and many projects don’t make economic sense at today’s $33/barrel price. In addition to the energy sector, many segments of the economy that support the energy complex will be hurt as well. If this price proves more than temporary, we’ll see layoffs and a slowdown in business spending.
The Federal Reserve cut short-term interest rates by 0.5% last week. There is talk they will cut further this week. If they don’t, the next scheduled Fed meeting is next week and further cuts seem likely at that meeting. I appreciate the Fed trying to help the markets, but the risk today seems well outside the scope of Fed policy. Lowering interest rates is supposed to entice companies to invest and help stimulate the economy. I don’t think any company is considering the cost of financing right now. People are concerned about a potential pandemic and what that means for growth. South by Southwest didn’t cancel because borrowing costs were too high, they cancelled because they didn’t want to help spread coronavirus by bringing thousands of people from across the country/world together in one location. Facebook and other companies didn’t cancel planned attendance at SXSW and other conferences over costs. They cancelled over coronavirus fears. That is to say, the Fed is doing what it can, but lowering rates doesn’t address the underlying issue in any manner in my opinion.
As I finish typing this, the Dow continues to claw back some of the morning’s losses. We’re now down just over 1,200 on the index. While still an historically bad day, we’re 800 points off the lows from earlier. This volatility isn’t fun, but the underlying fundamentals of the economy are strong. This volatility could last months. Stocks could keep going lower, but the key for a long-term investor is to weather the storm and focus on growth over the next 5+ years, not the next 5-10 weeks.
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A wild ride ended with stocks higher on the week. Each day Monday through Thursday, the major indices moved up/down by more than 3.6%. That’s unheard for volatility. Monday and Wednesday saw the Dow climb almost 2,500 points, while Tuesday/Thursday declined by a total of almost 1,800 points. Today’s 1% down move seemed tame by comparison. On the week, the Dow gained 1.8% while the S&P 500 increased 0.6%.
For consecutive Fridays, 500+ point rallies in the final hour of trading ebbed Dow losses. For all the bad news and down days we’ve had recently, I think it’s an encouraging sign that large investors were buying late on Friday. When panic really sets in, many investors prefer to sell and reduce equity exposure heading into a weekend. Weekends can be stressful because there are limited options to sell if bad news comes out. We’re still seeing a growing number of cases in the US, although the absolute numbers are still very small. My concern is I don’t see much/any evidence of containment and worry what that means in late April, early May. On the economic activity front, corporate travel is already being reduced. Numerous tech companies have cancelled conferences and stopped business travel. The well know SXSW conference held every March in Austin just announced it was cancelling this year after high profile companies like Facebook, Twitter and Tik Tok backed out. Other companies/industries are following suit. While a temporary situation, a prolonged halt in business/personal travel could push some airlines, cruise lines, hotels, etc into a dangerous financial position, including potential bankruptcies as they are dependent on daily cash in-flows to cover high fixed operating costs. Fear over an outbreak could push us into a recession, or near recession, although I would expect a sharp bounce back when the virus fears recede.
Mortgage rates are at historic lows right now. Refinancing activity is going through the roof. Wells Fargo announced today that all refinancings could take over 200 days because of the backlog of applications and appraisals. If you haven’t already, it’s worth a call to your lender/bank to see what rates they can offer. If you’re in PA, VA or MD, I’m happy to recommend a guy that is currently helping me refinance. Rates on 15-year mortgages were as low as 2.75% and 30-years were as low as 3.125%. If you need help deciding whether refinancing makes sense, send me your mortgage balance, current rate and current payment and I’ll give you some potential scenarios. If your current rate is 3.625% or higher, it could make sense to refinance. If your rate is over 4%, you should strongly considering locking in these low rates.
It tells you a lot about this week and what’s driving the market that the February jobs report didn’t get a mention until the fourth paragraph. The report was great, but realistically is pretty meaningless given what the outbreak could do to economic growth and employment in the months ahead. Microsoft came out today saying it would continue to pay its hourly workers even if the outbreak ended up reducing hours for certain employees. A generous offer for sure although one not every company can offer. Microsoft is holding $133 billion in cash so they can pay employees for a long time without bringing in another dollar of revenue. Most companies are not in that strong of a financial position. For the month, the economy added 273k net new jobs versus an estimate of 175k. Additionally, December and January were revised higher by a total of 243k new jobs. The unemployment rate dropped to 3.5%.
Oil sold-off sharply again this week, decreasing another 8.2% to close at $41.51/barrel. The yield on the 10-yearr Treasury collapsed to close at 0.77%, from 1.16% last week. During the week, the 10-yr Treasury set an all-time low on yield trading briefly under 0.7%. The average rate on a 30-yr fixed rate mortgage moved lower to 3.29% from 3.45% a week ago.
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US markets suffered their worst week since the financial crisis. The major indices have now been down 7 straight days. The Dow declined an incredible 12.4% this week while the S&P 500 decreased 11.5%. So, what happened? Like I said on Monday, I think a confluence of factors, led by coronavirus fears drove this move down. Interest rates are plummeting. The 10-yr Treasury set an all-time low of 1.1% today. People are nervous about growth slowing independent of the virus, which is pushing rates lower and pressuring stocks. Program and algorithmic trading is a technical driver of this sell-off. As stocks keeps going lower, computer programs continue to execute more and more sell orders. In a market with few buyers stepping in, that keeps pushing prices lower to find a buyer. But the single biggest driver is growing concern over the the lack of containment of the coronavirus.
Big picture, the coronavirus is going to be a temporary situation. Scientists will figure out a treatment/vaccine and the number of new cases will eventually slowdown. The question is when will we get some positive news on that front. It seems all the efforts to contain it have been unsuccessful. We don’t fully understand the incubation period or transmission and scientists believe many people who have it can be asymptomatic. This means people can be silently infecting other people without even realizing they are sick. I view this development as having some pros and cons. The bad news is the virus can be transmitted in a manner where doctors won’t be able to find the source, making containment near impossible. The good news is, if some number of people getting infected don’t have symptoms, or have minor symptoms, the death rate, currently around 2.5% is actually going to be lower than that since the number of cases is higher than currently believed. From various things I’ve read, the number of cases in the US is going to start increasing, potentially quickly.
Since we believe this will be temporary, why is the market selling off so much? The impact to global growth is the key. Disney Tokyo announced it was closing for at least two weeks to slow transmission of the virus. An LPGA golf event in Japan in being played without fans this weekend to minimize human interaction. Japan announced all its schools are closing during March. Conferences in the US are being cancelled or considering cancellation. A high school in Seattle has been closed for two days and the CDC is telling schools in the US to put together plans for mass closings. Business travel is being cancelled. All this adds up to a significant drop in economic activity. This situation is very different from the financial crisis, but in the 4th quarter of 2008, economic activity dropped to a near standstill. One of the more amazing stats from that time period is that Volvo, a major commercial truck manufacturer, sold only 8 trucks that quarter. That significant drop in economic activity could wipe away growth for the entire year, even if it only lasts a few weeks or months. There will be a rebound in growth on the back end of this as pent up demand boosts growth, but hotel rooms, flight seats, oil used, dinners out, etc that are missed, can never be recovered. That is the risk people are nervous about. How much will economic activity slow and when will it start up again.
How are we dealing with this environment? I sold some positions earlier in the week to raise cash and provide a little stability in portfolios. Overall, we’re down about 60-65% as much as the indices. One encouraging sign came right at the close today. The Dow was down over 900 points at 3:45pm and yet closed down ‘only’ ~350 points. That suggests mutual funds were net buyers on the day and some amount of capital stepped in thinking we are at/near a near-term bottom. That’s no guarantee there won’t be additional weakness next week or beyond, but the move this week has priced in a lot of risk already. We’ve lived through several similar/worse corrections over the last 10-years, including a ~20% decline in the market in the 4th quarter of 2018. We saw similar weakness during the Greek debt crisis, Cyprus banking crisis, Brexit, etc. This has been different in that we declined a lot faster than previous corrections. In fact, this drop was the shortest number of days between a recent market high (2/19) and officially being a correction with a 10% down move. So the speed of this has felt bad, but the actual move has so far been equal, or less severe, than the past 4-5 corrections. If you have questions or want to talk through your portfolio, please reach out. This was an unsettling week that probably felt more unsettling because we’ve had a good 14 months of positive markets.
Oil sold-off significantly this week, decreasing 15.3% to close at $45.23/barrel. The yield on the 10-yr Treasury moved sharply lower to close at 1.16%, from 1.47% last week. The average rate on a 30-yr fixed rate mortgage moved lower to 3.45% from 3.49% a week ago. With the sharp drop in Treasuries this week, mortgage will likely fall sharply next week. If you have considered refinancing, I would reach out to some lenders and see what rates you can get next week. Could be historically low.
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The Dow traded down over 1,000 points and finished with the second largest single-day point decline in history. The largest point decline occurred two years ago, on Feb. 5th, 2018 when the Dow declined 1,175 points. While the point total was high, today’s sell-off isn’t in the Top 10 in the more relevant percentage terms. The biggest single-day drop in Dow history occurred on Black Monday, October 19, 1987 when it declined over 22%. So, what’s going on today? Most of the headlines have blamed a growing fear over the inability to contain the coronavirus. I believe that’s partially correct, but not the full story.
Coronavirus is a concern, and cases are appearing around the globe. The US has 34 confirmed cases and a large outbreak is starting in Korea. Over the next few weeks, we could start to see product shortages on goods made in China and other places. This will slow economic growth in the this quarter and could carryover into next quarter. However, I don’t see this a long-term problem. Researchers will find effective treatment and/or a vaccine. Additionally, when the supply chain is back up and running, pent up demand will likely help fuel stronger than trend growth later in the year.
Interest rates are another area of concern. I wrote about the 10-Treasury rate dropping below 1.50% last week in the weekly recap. In addition to the US rates, many parts of Europe and Japan are seeing some negative interest rates. That means that investors are actually losing money to buy these bonds. Many buyers of sovereign debt aren’t yield sensitive for various reasons, but seeing US rates trend towards Europe and Japan suggests many investors are nervous for future economic growth. It’s important to note we’ve seen similar moves in rates during the Greek debt crisis, the Cyprus banking sector collapse, Brexit and several other inflection points over the last decade, but growth has generally continued higher. I think the economy is still reasonably strong right now and this move in interest rates seems overdone and not predictive of an upcoming recession.
Another important factor in days like this is quantitative trading. Many hedge funds build complex algorithms that dictate trading. These programs have automatic sell orders built in based on a variety of factors. Certain stocks drop by a certain percentage and the programs sell. If indices drop by a certain amount, the programs sell. This can lead to a selling begets selling situation. As stocks keep declining, more programs trip requiring more selling. This can push a mediocre down day into a full-blown sell-off like we witnessed today. These days happen. They are never fun and sometimes the sell-offs continue for several more days or even weeks. While it’s impossible to know what the future holds, every time we’ve had a sell-off like this over the last decade, they’ve been short-lived and stocks eventually kept moving higher.
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