After yet another crazy, volatile trading day, where investors saw sharp declines at the opening bell on Wall Street, the S&P 500 managed to claw its way into the green by finishing up around 0.50% while the tech-heavy Nasdaq outperformed gaining 2.30% led by “FANG” names Facebook, Amazon, Netflix, and Google. Oil, which had collapsed nearly 60 percent since the end of 2019 rebounded sharply gaining over 23%, marking its biggest one-day percentage gain in history.
While all theme parks are closed because of the virus, the roller coaster on Wall Street is running 24/7 and at Capstone, we are still urging clients to continue to brace for more selling and potential further downside as headlines about the Coronavirus, oil shocks, and a looming credit crisis roll on while we desperately search for any confirmation of bottoming process in stocks. So what should we be looking for? What does the bottoming process look like?
First, let me say that, notwithstanding all of my more recent “draconian” messages, there has been a significant amount of damage done in the markets that, and at this point, should foster less “doom and gloom” now than what we saw a few weeks ago. Having said that, I believe that we are not out of the woods at all at this point because of a few factors. First, I think that there are too many “bottom callers” in the market right now…Every other “talking head” in the media is placing bets left and right that the bottom is in, and investors should be buying up bargains at current prices with both hands. While I believe that there may very well be bargains in this market, the conditions that must be in place to call a market bottom, in my view, just do not exist - yet.
Some of those conditions are below:
Capitulation: Despite the massive declines that we have seen in the markets, I don’t believe that we’ve seen “total surrender” yet where market participants are forced to sell stocks at any price available. This is where, in a war, we’re “shooting the generals.”
Coronavirus: In order to form a bottom, we need positive reports about Coronavirus…At every turn, the market has plunged when even a negative whisper related to the virus is in the news. So far, the market is not able to brush off bad news here and, since this is unchartered territory, it seems the market will continue to run in the other direction as the undesirable narrative of the illness controls the airwaves.
Oversold Market: Market indicators that measure exaggerated moves in stocks have recently been showing the most extreme levels of selling pressure on record but, still, buyers are not showing up yet. Historically, when the markets are this oversold, it spurs a buying frenzy that would push stocks higher in a very amplified way…We need to see bigger moves to upside, in my view, in order to confirm the bottoming process. For example, if the headlines read that a new therapy for the illness is available and able to treat the novel virus effectively, we could see a 3,000 – 4,000 point move upward in the Dow and that, in my view, would spell conviction of a bottoming process to the markets.
Retracement: We can use past bear market corrections as a guide and bear markets seem replicate each other over time…So far, we have seen from the peak of the market in January, a 30% decline in our markets but, historically, all other major bear markets experienced greater losses: in the Great Depression markets took a gigantic hit of over 86%, the recession in 1974 saw losses of 48%, in the 2001-2002 recession, where technology stocks entered a “nuclear winter”, the markets fell 49%, and in the Great Recession of 2008-2009, we fell 56%. If history is to repeat itself here, unfortunately, there’s more room for the market to fall in the near term.
Stocks versus Bonds: The bond market is way bigger than the stock market will ever be and, even though the stock market gets all of the attention, it’s the bond and credit markets that are telling the story right now. If you are listening to financial analysists and some news journalists, many of them are saying that this crisis is solely biological in nature and is not creating any type of financial crisis. “This is not 2008 and 2009 all over again” is what I keep hearing out here and to some degree, I differ with that opinion. There are currently about 45,000 publicly traded companies and out of that group, 17% are now being deemed as “zombies” because these companies don’t have enough revenue, cash flow, or profits to pay their debts…In the past, the only way these companies kept their heads above water was to constantly refinance and issue new bonds over and over again – Peter, please meet Paul. Now, because of the stresses in the marketplace, new issuance of debt has completely dried up and, unfortunately and in many cases, the answer will be bankruptcy. At this point, in my opinion, the bond market has not yet corrected enough to price in these types of toxic risks.
Margin: In this kind of market, borrowing money to invest in stocks is very dangerous and it’s important to follow stock price levels each day, especially going into the final half hour of trading, to assess how much stock must be sold by investors in order to raise enough cash to satisfy margin calls against their investment portfolios. During the ’08-‘09 financial crisis, trading in the stock market, at times, appeared to be stable going into the close of business until quickly reversing course as sellers covering their leveraged bets tore the markets apart. Although we have certainly seen this type of end-of-day selling pressure several times during this current global takedown of stocks, there is still a significant amount of margin debt in the system and until most of those leveraged investors are shaken out of the market, I expect a significant amount of market volatility to increase in the near term.
At this point in time, fundamentals in the market are essentially meaningless. The market is technically repricing to reflect a downturn in the economy and a decline in corporate earnings. The overall impact can’t really be quantified, so the market is in “ready, shoot, aim” mode at the moment. Over time, I expect to see the conditions I mention above to play out and the bottoming process to be validated. This should be welcomed by beleaguered investors and because the market is a discounting mechanism, we should also expect it to bottom out before the worst of the bad news is out.
As I have mentioned time and again, the advisors at Capstone have been preparing portfolios to get through some kind of downturn since last year. We were selling stocks in the summer of 2019 during upward markets and, more recently this month, we greatly reduced and in some cases eliminated certain risks in client portfolios by decreasing exposure to certain asset classes that we concluded were no longer worth the risk. Going forward, we will continue to assess the markets and rebalance portfolios accordingly.
Markets go up. Markets go down. It’s part of life, investing, and economic cycles. Whether it’s a dot.com bubble, debt crisis, or a once in a 100-year epidemic, it just happens and investors need to know how to cope with it psychologically and their investment portfolios have to be built to last. We should not be fearing the markets at this point but, should stay focused on long-term investment success and recognize that the only way to be “right” is to stick to the plan and have a disciplined investment strategy…
If you’re not yet a client and you don’t have a plan or a strategy, call us. You should know what risks are in your portfolio and know how to control those risks. We can’t stop the stock market from doing its thing at this point and we think it’s too late to sell stocks, but risk management is always key. If your portfolio contains too much risk, you should mitigate it and, at Capstone, we would be happy to help!
For our clients, as always and at all times, please call us with all of your concerns and questions at (570) 587-7800 (office direct) or 888-587-7526 (toll free).
(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.)