Month: April 2020

The title of this blog post comes from the 1990s HBO docudrama starring Matthew Modine as epidemiologist Don Francis.  It is based on the true story of the CDC as they first came into contact with the HIV virus in the early 1980s.  It happened to be one of my father’s favorite movies, so it became one of my favorite movies (funny how that works).  If you have a chance (and I know you do), see if you can find the movie and give it a watch.

In the movie, the mantra of the CDC when dealing with this previously unknown type of virus was simple, “What do we think? What do we know? What can we prove?”

I use this method often when analyzing markets. Let’s go through the exercise together.

• What Do We Think?
  • We think that life on the other side of Coronavirus will look different than it did before.
  • We think small businesses will not return to the same importance for the overall economy and large corporations will become even larger.   Essentially everyone will be spending money at the same four places (Grocery Store, Online/Retailer, Healthcare, Technology).
  • We think that we will be ushering in an increasingly digital workplace and world.  This had already been happening and perhaps this will just speed up the process.
  • We think the stock market is disconnected from reality since it’s not properly reflecting an economy working at roughly 50% (if the stock market reflects the economy, why aren’t stocks down 50%??).

All of these items sound pretty logical.  But the market doesn’t care what anyone thinks, including me.  It’s truly irrelevant, and even if we were lucky enough to predict exactly how the economy would look in five years, would you be able to profit from it?  “The stock market is a second level thinking mechanism (there’s that phrase again!). While most of us see the world for what it is, the stock market is always trying to see the world for what it might become.” – Cullen Roche

Based on what large institutions think, they buy companies that they believe will profit the most in the coming weeks/months/years.  Are they right?  Even they don’t know that one…

“If you’re confused or upset by the stock market action, just sit with it. Let it marinade on you. Learn to be comfortable being confused and uncomfortable. That’s way more productive than desperately searching for logic. There is no logic. Start there, and be free of the need to understand.” – Tom Canfield

• What Do We Know?
  • We know there are 152 million American workers.  We know 22 million of them lost their jobs in some capacity over the last month.  That number is likely to move above 25 million, but we won’t know until tomorrow.
  • We know that central banks and governments throughout the world have intervened in an unprecedented way to try and avoid/alleviate a recession or even a depression (full employment is one of the two Federal Reserve mandates).
  • We know March was the most volatile month for the S&P 500…ever.
  • We know that sentiment reached pessimistic levels not seen since the global financial crisis. 

• What Can We Prove?
  
  • We can’t prove much about the future, so we look to the past to show us what’s happened in previous periods similar to this one.
  • The S&P 500 has gained 15.5% in the last two weeks.  According to Ryan Detrick of LPL Research, since World War II, the S&P 500 has gained more than 12% in a two week span three different times: October 1974, August 1982, and March 2009.  One year later the S&P 500 was up 22.9%, 37.3%, and 51.7%, respectively.
  • The market remains highly bifurcated into big winners and losers.  Over the past 12 months, the largest companies (S&P 100) are up 2%, while the smallest companies (S&P 600) are down 24%.
  • On one particular day last week the Nasdaq 100 (technology sector) was up over 1% while the S&P 500 was down more than 1%…since 1985, this has NEVER happened.  – Jason Goepfert

“The only thing I have a strong conviction about right now, is that nobody should have a strong conviction about anything right now.” – Walter Deemer

There are many reasons to believe that the market will pause for a bit at this price level.   As we outlined in an email to clients at the end of March, the furthest rally for the S&P 500 we were prepared for was 2880-2900.  The intraday high price last Friday was 2879.22.  Close enough.  While we are still in the “retest the lows” camp, we must admit that if we are to deviate substantially above the 2900 level, the likelihood of a “V” recovery increases.

There is more volatility to come, so please don’t get complacent and think everything has been solved.  We still believe this will be a months/years long process for main street to get back on its feet.  But that doesn’t have to mean anything as it relates to the stock market.  Also, don’t delve down the rabbit hole of pessimism either.  It’s a convenient rocking chair, which gives you something to do for awhile, but doesn’t get you anywhere.

In our “Green Shoots” post, dated March 20th, we outlined our view of how the markets could react positively over the coming days/weeks ahead even though the markets looked bleak.  We believed that the market was oversold and was due for a rally from those levels.  I’m happy to report that since the closing price on March 20th, the S&P 500 has risen 19%.

In our quarterly performance reporting emails, we mentioned specifically that the area of 2720 was a natural point where sellers could return to the market to lighten up their holdings.  Today we reached this first checkpoint.  While the market can still move higher from here (positive breadth and volume have been encouraging in the recent days) and we’re open to the possibility of 2900 on the S&P 500, I do believe Phase 2 of the traditional crash cycle is coming to an end.  Phase 3, the eventual “retest” of the March 23rd lows, is most likely upon us.

Let me stop for a second and mention to everyone that there is no equation, no rule book, nor any secret decoder ring that predicts how this is going to shake out.  We only have history as our guide.  2008 was an outlier of a retest in the fact that it went BELOW the old low in March of 2009.  This also happened to mark a generational stock market bottom and a generational buying opportunity.  Most of the time, the retest ends up being within 4% of the old low (not necessarily a ” lower low”), but each time is a little different.

The real reason for this post is to give some guidance moving forward.  Today the S&P 500 reached the same price level it was in June of 2019.  This means that the return for the S&P 500 over the last 9 months is 0% (surprising isn’t it?).  While Phase 2 may be over, or may have a bit more to go, we are still in the camp of believing that the market will heading lower over the coming weeks.

So…if you’re a younger client and have a long time horizon, the traditional rebalancing (moving a small portion out of fixed income, into equities) remains our preferred method moving forward.  For those of you who are taking income from your portfolios and using it for living expenses, we’re going to try and take the opportunity on this rally to move up the quality spectrum and get a similar amount of dividend yield from companies we believe are less likely to reduce or eliminate their dividends, and hopefully we could see some capital appreciation eventually as well.

Ideally if you’re sitting on cash and feel comfortable adding to your existing positions, or have been waiting on the right time to jump back in, our recommendation would be to do so on the retest (at the moment we feel this level is around S&P 2400).

For those of you who find yourselves losing sleep about market losses, feel like you’re not able to ride out another storm due to age or potential job instability, NOW is the time in this cycle to sell some of your equity holdings to insure that in the highest number of probable scenarios, you’ll still get to where you want to be at retirement and beyond.

If you find yourself in this camp, please call or email at your earliest convenience.

– Adam