We hope you and your family are doing well and staying healthy during this unprecedented time. It has been exciting to see all the creative ways Americans have come together to help one another and interact while still practicing social distancing. This past weekend I had a neighbor celebrate her 90th birthday. There was a caravan of cars that was led by a police escort. It was exciting to see her smile and feel loved even though she couldn’t hug those closest to her. It has been a challenging time for many, but I remain optimistic that we will arrive on the other side as a more generous and caring society than ever before.
You should have received your electronic quarterly reports on Monday, April 20th. For those still receiving paper copies your statements should hit your mailbox in the next few days. Below is our quarterly commentary that summarizes the first quarter and discusses where we may go from here. We hope you enjoy it!
The first quarter of 2020 was one for the record books. Unfortunately, the records that were set are those that many of us would like to forget. It was the worst first quarter ever for both the S&P 500 and the Dow. You heard that right – ever! March delivered two out of the six worst trading days ever for the S&P 500 with daily declines of 12% and 9.5%. In addition, the S&P 500 had the fastest 30% drawdown in history which took only 22 days! The S&P 500 was down 20% for the first quarter and was down almost 34% from the market high set on February 19, 2020 to the market bottom on March 23, 2020. Many asset classes such as small cap, real estate, and international saw even greater declines. The unprecedented volatility can best be viewed by segmenting the quarter into 3 time periods.
- Jan 1 – Feb 19 – S&P 500 +4.81%
- Feb 19 – Mar 23 – S&P 500 -33.92%
- Mar 23 – Mar 31 – S&P 500 +15.52%
Throughout this pandemic we have heard comparisons to the Great Depression (1929-1933) and the Great Financial Crisis (2007-2008). These are periods that you never want to be compared against but is where we currently find ourselves. With that said, I think it is important to review these periods and see what we can learn. The Federal Reserve has been very quick to act and implemented a CARES stimulus package at a magnitude 5X greater than the TARP implementation in 2008. Below are the three most recent modern-era crashes and the ensuing recoveries. We are not attempting to predict what a recovery may look like but rather showing how markets have reacted during and after these historical events.
- 1987 Crash – 34% crash over 3 months / 417% recovery over 113 months
- Tech Bubble (2000-2002) – 49% crash over 30 months / 101% recovery over 60 months
- Global Financial Crisis (2007-2009) – 57% crash over 17 months / 401% recovery over 132 months
*Source – JPM Guide to the Markets (March 31, 2020)
Where do we go from here?
To begin answering the question of where do we go from here, I think you must start by answering a few other questions:
- Is the recent rally a dead-cat bounce (a temporary recovery in share prices after a substantial fall, caused by speculators buying in order to cover their short positions) or the start of a new market recovery?
- How did the S&P 500 rally 27% over 15 days from the bottom on March 23rd when the economy is shut down and the US is shedding 5 to 6 million jobs per week?
- Are we entering a recession or a depression?
The recent market rally is difficult to understand when compared against the daily economic backdrop. To understand this difference, I believe it is important to remember that the stock market is not the economy. Sure, the stock market often trades in correlation to economic news but there are many periods throughout history where the two decouple. Keep in mind that the stock market is generally a leading indicator and is typically 6-9 months ahead of the underlying economy. When the economy is quickly changing it is not uncommon to see this divergence between the stock market and the economy. The recent swings we saw to both the downside and upside were the market trying to price in estimates of what future earnings will be for corporations.
Furthermore, I believe answering the third question, first, helps to explain questions one and two. It appears the markets believe a depression will be avoided and as a result were pricing in this information. This does not mean that we won’t continue to have some difficult days ahead (I actually think we will), but we are starting to see increased support that the bottom set on March 23rd has the potential of holding. This is important as a bottom is needed before a new recovery can begin.
Unless you are 87-years-young, you have never experienced a depression. Sure, we have all heard stories and read different accounts in history books, but I am certain that the firsthand vantage point would tell a very different story. The technical definition of a recession has always been clear and universally accepted – two quarters of negative GDP growth. What I find surprising is that a depression is much more difficult to define. The depression definition is very vague with the most consistent being a prolonged period of economic recession marked by a significant decline in income and employment.
I think we can all agree that we are entering into a recession. While we have not technically triggered the definition, I would argue we are already there. With the economy shut down we are expected to see a significant Q2 contraction. Analysts have predicted anywhere from a 15% to 50% slowdown in GDP on an annualized basis. Since these quarterly contractions are annualized it is likely the year-end slowdown will not be nearly as bleak as the Q2 annualized numbers assuming the economy can get rebooted in the second half of the year. We have also heard unemployment rates ranging from 10% to 25%. With GDP collapsing and unemployment soaring why do the markets believe a depression can be avoided?
Today, we have tools (right or wrong) that didn’t exist during the Great Depression along with lessons learned from past crashes that many believe will make a dramatic difference in our eventual recovery.
- The Fed – The Federal Reserve was relativity new during the Great Depression. The Fed failed to act during the depression and in many ways their policies made the situation worse. Compare this to the current version of the central banking system which has acted swiftly and boldly. Furthermore, we have seen a coordinated effort by central banks around the world to pump liquidity into the financial system and ensure that it can continue to function. This cannot be overlooked and is a significant step in helping us emerge on the other side less battered and bruised than we would without this aid.
- Government Spending – Past crashes have left individuals and business unable to spend and invest at levels that allow for sustainable growth. The government can offset this decrease by increasing its own spending thus helping ease the downturn. During the Great Depression, the government sought to balance the budget and attempted to shrink its own spending by 25%. In hindsight, this made the problem worse and ultimately led to a multi-year depression. During the current crisis the government is looking to spend 10% or more of GDP to help offset the decline in economic activity. Additionally, the following social safety nets did not exist during the Great Depression: Social Security, Medicare & Medicaid, FDIC insurance, unemployment insurance, and the SEC. Many of these programs were developed from lessons learned during the depression and will dramatically help the American society during this crisis.
- Markets and the Financial System – Our markets and financial system are much more mature today than they were during the Great Depression. In addition, because of the lessons learned during the 2008 Financial Crisis, our banks are in a much better position to absorb this downturn. In many ways, 2008 was much scarier from an economic standpoint because our financial system was on the verge of collapse. Today the banks remain strong, and the Federal Reserve continues to do what is needed to ensure ample liquidity remains in the banking system.
What should you do?
- Young and working age (10+ years from retirement) – Keep saving and investing while the market is on sale. These periods offer the greatest opportunity for future returns.
- Pre-retirees and retirees – Make sure you have a well-diversified portfolio. We strive to maintain a minimum of 6-10 years of portfolio withdrawals in fixed income and cash holdings which allow your equity positions to recover without the need to sell while they are undervalued. You may also want to consider having your stock position rebalanced back to target levels.
What have we done?
We took steps on the fixed income side of your portfolios to increase credit quality and to help ensure that your fixed income and cash holdings continue to act as a hedge against continued market volatility. We have also been very active in tax-loss harvesting which can be used to offset future capital gains.
We will continue to maintain our long-term view of the markets and will be rebalancing our client’s more aggressive portfolios back to their target allocations. We believe the virus will be defeated in time, and the American economy will once again show its resiliency as it has throughout history. American ingenuity has already been on display as companies have adapted to new ways of doing business. Furthermore, the private and public sector have come together in a coordinated effort to find treatments and an eventual vaccine. I believe that we will emerge stronger and better as a whole. Patience during these periods is a virtue.
Take this extra time to slow down, love one another, and enjoy the beauty that is all around. In some ways, I think the greatest gift from this virus is that we will all learn to appreciate the small things in life again and hopefully our priorities will be forever changed.
We are forever grateful for your continued support. Please reach out to your lead advisor if we can be of assistance. We look forward to meeting with many of you virtually in the coming days, weeks, and months. Stay safe and healthy and enjoy the better weather.
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