Capital Market Comment
March 16, 2020
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
Last Thursday marked the largest daily decline (10%) on the Dow since Black Monday during the 1987 Crash, while also recording the largest daily increase (9.3% on Friday, March 13, 2020) since the financial crisis on October 28, 2008.
The coronavirus and the uncertainty about its economic consequence, roiled the markets and produced unprecedented volatility. Recession forecasts have proliferated as expected, with some even suggesting the entire year 2020 would be a down year. Most certainly, over the near term, economic activity will decline and maybe quite sharply. However, over the intermediate to long term, many assumptions are being made about consumer behavior, even though this behavior is difficult to capture.
Consequently, these forecasts have limited value. Many Americans have reacted as they have in the past to disruptions in their daily lives by stockpiling what they view as essential items. Store shelves are empty of many items, similar to Y2K, the 1970’s gasoline crisis, hurricanes, etc. All were temporary developments but were dictated by the duration of the crisis.
The September 11, 2001 terrorist attack, the Russian default crisis, the Asian contagion, 1987 market crash all caused significant declines in business activity, but did not cause recessions in the traditional sense (multiple quarterly declines in gross domestic product). Every shock is different, as well as the consequences. The coronavirus crisis will not be an exception.
Most importantly, policy responses are well underway. The Federal Reserve cut rates two weeks ago and the declaration of a national emergency has set in motion counter cyclical forces. Fifty billion dollars has been released, a business-government partnership has emerged, and a second coronavirus bill has passed the House. The President indicated he will sign it when it passes the Senate. A third bill is likely to emerge in the coming weeks.
Fiscal buffers have been increased and monetary accommodation has moved to a new level. Sunday night, the Federal reserve embarked on an aggressive program in which it agreed to do the following:
- Lower the Fed Funds rate 100 basis points to 0 – 0.25%;
- Buy $700 billion of government and mortgage backed bonds;
- Cut the rate of emergency lending at the discount window for banks by 125 basis points to 0.25% and lengthen the term of loans to 90 days;
- Cut reserve requirements for thousands of banks to zero; and
- Coordinate with central banks around the world (Bank of Canada, Bank of England, Bank of Japan, the European Central Bank, and the Swiss National Bank) to enhance dollar liquidity around the world through existing dollar swap arrangements. (The banks lowered the rates on these swaps and extended the period of the loans.)
Economic activity at the end of Q1 and the beginning of Q2 – the time of most disruption from the response to the virus – should experience a significant decline (travel, airlines, hotels, tourism, transportation, entertainment, restaurants, store closures, etc.). However, the response of many enterprises to cushion the impact on their employees should lessen the blow to jobs. The impact of the virus is likely to be severely felt by the companies through lost revenues and profitability. Given the short-term nature of the virus, absorbing the employee cost could well prove beneficial to employee morale over the intermediate to long term.
Earnings for the first and second quarters are going to be unusually weak and there will be wide “guestimates”. Companies are likely to be conservative and absorb the adverse impact in Q1 and Q2, thus setting the stage for a strong rebound in Q3 and Q4. No one knows how quickly the consumer, in particular, will rebound. We do know consumers have a high saving rate (7.9%) and the rate is like to go higher during these uncertain times. Also, when things improve, consumer spending habits might be somewhat different from before the crisis. At the same time, the post-virus environment will be different as new policies and procedures are implemented by government and businesses. Additionally, the healthcare system is likely to undergo a transformation based on the lessons learned from responding to the crisis.
Over the next several weeks, we will be in the middle of the worst impact of the virus on our daily lives, the health of our citizens, and the economy.
At what point will the financial markets begin to look toward the recovery phase, and assess the impact of the fiscal and monetary policy stimulus actions? In the financial markets, fear and panic has engulfed participants and observers alike. Some stocks fluctuated as much as 15 – 20% from the low of the day to the close. Such price fluctuations reflect panic behavior, generate disruptive executions for those who were compelled to sell (also the bid and ask price was very wide).
The price behavior was similar to the 1987 crash, where price realization was equally dysfunctional. However, unlike today, the technology was not available to handle the volume at that time. Consequently, the prices of transactions were not known for hours.
Imagine you are selling your home and it is priced at the market, but the next morning your realtor tells you that you have to sell for 10% less. The next day you are told it is now 20% less than your asking price. What do you do? Most likely you pull the listing and wait for a more orderly environment. Has the value of your home really changed that much in two days? That is what is going on with the stock market.
Last week alone a massive exodus of stocks into bonds occurred, a phenomenon that has been going on for weeks. Given the magnitude, the speed of the decline, and the volume, the capitulation phase appears near at hand.
Once the dust settles, several factors are likely to be present. Interest rates will be significantly lower and the yield curve restored. Monetary growth will accelerate and the Fed’s balance sheet will continue to grow uninterrupted. Central banks around the globe will have embarked upon aggressive monetary accommodation and their fiscal tools will gradually be employed. Growth would be expected to resume following severe weakness. That environment should be conducive to the return of orderly markets and valuation matrices that suggest that stocks might well be the asset of choice again.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or email@example.com
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.
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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.