Now that we are faced with the reality of a worldwide pandemic, what comes next?
Both equity and fixed income markets have had their worst one day performances since 1987 and 2008, respectively. In the past two weeks, we have seen 4 of the 7 worst daily performances for fixed income markets since the financial crisis. The knock-on effects of the virus have already disrupted global supply chains for many products which originate in, or rely on, China for critical components. This supply reduction directly results in less economic activity as factories waiting on parts idle and workers stay home. Eventually, it also prevents other companies from providing goods and services that rely on those delayed parts. In addition to this supply shock, fear and uncertainty in the age of social media has spread at unprecedented speed, causing a chilling effect for demand. People may have bought tons of Purell, but they may also start limiting trips to the movies, going out for dinner, or taking a vacation until they (eventually) believe it is safe to do so.
Governments across the world are working furiously to keep up with events as they occur, but this is a massive task which requires coordination, resources, and no small amount of luck. As we are seeing in Western Europe (namely, Italy, France and Ireland) the standard response has been a combination of extreme social distancing and forced lockdowns or quarantines of affected areas. These measures have escalated in the last 24-48 hours and we are seeing cancellations of massive events including: professional sports seasons, concerts, conferences and even the shifting of university classes to a fully online environment. These cancellations are not ideal from an economic perspective as they magnify the demand shock and increase uncertainty even further. The end result: a much higher probability of recession due to the combination of the supply and demand shocks described above.
We have now officially entered a technical bear market, which signals the end of the longest bull market in modern US history. The last decade brought huge increases in asset values, and in some areas, an excess of corporate debt leverage and high company valuations. Bull markets do not die of old age, they typically succumb to a combination of irrational exuberance and an unforeseen shock (also known as a “Black Swan”). The last 5 to 10 years have produced massive price growth, not dissimilar to when a forest receives a great deal of rain and develops excess underbrush and dead trees. The “excess underbrush and dead trees” of corporate leverage and high equity valuations have served as the tinder for the market wildfires of the past two weeks. The spark (Black Swan) was the impact of the coronavirus. Bear markets are characterized by high volatility to both the upside and downside. When they do correct they might be swift which means that we, as investors, must be prepared.
As the situation worsened several weeks ago, we made some defensive maneuvers across most portfolios. By doing so, along with existing strategic positioning, we helped to shield client portfolios from much of the market downturn, but this is not the end of the story. We believe we are likely in the early innings of a protracted volatile market environment. We now find ourselves in a situation where governments and central banks are scrambling to find answers and coordinate plans to address both the health and economic issues before us. The outcomes of these responses will have significant implications for both the economy and financial markets.
As always, the health of our clients, families and friends is paramount. In addition, we are all working diligently to monitor and analyze events as they unfold. There will be economic winners and losers among companies and sectors, which will bring about great buying opportunities. It is also important to remember market cycles and fluctuations are inevitable—we must maintain a long-term perspective. In our opinion, now is the time for investors to hold fast, stay disciplined and think rationally. That is our mindset as we work to prepare for those future opportunities and safeguard our clients’ capital for the long-term. We understand that in these trying times everyone will respond differently. Our team at Charlesworth & Rugg, Inc. is here to support our community—please feel welcome to contact us.