What a difference a month makes. After plunging into to freefall earlier this year, the S&P 500 has jumped almost 700 points as the benchmark index has not only stopped the bleeding, but even has some investors thinking the bear market is now over. Over? In one month? Really?
The primary and perhaps ONLY reason that we have experienced this massive rally on Wall Street is due to the actions taken by the US Federal Reserve and US Treasury. The governmental intervention is like nothing that we’ve ever seen. In my March 24th note to clients, I explained how the Fed and the Treasury were throwing the “kitchen sink” at the Coronavirus and in that message I discussed the what the anatomy of a bear market might look like. As investors, we can learn from past downturns and, at least to a degree, set and manage our expectations during this one.
So, is the bear market “over” now? I don’t believe so and in my April 1st message to clients, I explained that in most bear markets we can see, from peak to trough, 35% or more in market declines and that the downturn can also lead to subsequent “relief rallies” of 20% or more. These relief rallies are very common occurrences during bear markets and they can be very enticing to investors who come running back into equities believing that the coast is clear. In theory, I suppose that anything is possible and we CAN be in store for a massive “V-shaped” recovery, but at Capstone, our advice to clients is to observe caution, mitigate risk wherever possible, and to be realistic. We are in unchartered waters when it comes to the pandemic and it will surely leave lasting implications on our economy and the markets for years to come. Capitalism in the US will almost never be the same as the tidal wave of virtually unlimited amounts of quantitative easing and government spending fills up the punch bowl like never before. The spending is unparalleled and it’s actually not surprising at all to see the markets come roaring back like they have. But can the rally be trusted?
There are reasons to keep our guard up. We live in a debt-driven economy and 90% of US Gross Domestic Product, a measure of economic growth, was produced by the consumer in 2019. Now, with the US consumer on the COVID-19 ropes, it’s just about impossible to determine the economic damage from here and into the immediate future. We might not feel it yet, but the shocks to our economy are probably way worse than what they were in the 2008-2009 financial crisis and since then, we have lost every single job that was created (at least in number), millions are filing for government benefits as unemployment might reach 30%, government debt is bigger than ever, low interest rates are now a sign of weakness and economic trouble, consumer demand will probably be sluggish at best in the near-term, stock buy-backs (which have been used for years to maneuver earnings per share figures) are likely gone, and it might take several years for corporations to reach the same level of profitability that they just saw in January of this year. Yes, for the moment, the government bailout has created a sense of stability and calm for investors, but the real questions that need to be answered are – did we fix any fundamentals? Or did we just fix prices?
There’s a classic battle occurring right now between economic weakness and government stimulus. Over the last month or so, the stock market is clearly sitting in our government’s corner but I suspect we won’t see any white towels hitting the canvas from the weakened economy anytime soon. We are facing a potential “societal shift” in our economy. Some people are actually finding themselves making more money on unemployment than they did while they were working, we are going to see many bankruptcies, junk bonds are currently priced with a better valuation than the S&P 500, there’s no telling when the shut-down will let up, and, unfortunately, some people’s lives are completely ruined financially.
There will be significant challenges ahead. If we open back up quickly, yeah, maybe then we can see the “V-shaped” recovery that we’re all hoping for, but I’m afraid it’s unlikely. Readers of this post might remember a few messages that I sent out last summer about complacency in the markets. Complacency is never a strategy and, at Capstone, we use times like these to ensure that client portfolios are well balanced, investment risk is in line, and asset allocation strategies are firmly in place. We have been actively managing client assets during this period, reducing risk where necessary, and, in some cases, using volatility as a tool to take advantage of opportunities.
We expect volatility to return and our experience tells us that, unfortunately, there is still a chance that stocks can retest the bottom that we saw last month and a retreat from current levels would not be surprising at all.
If you’re not yet a client of Capstone’s and share some of the concerns that are in this message, call us for a free consultation. We can help and be reached by calling (570) 587-7800 (office direct) or at 888-587-7526 (toll free).
For all clients reading this post, you know that we’re here for you anytime and, while we’re socially distancing, we are available by tele-conference or online video. Please call us to set up a meeting.
(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.)