Economic Backdrop and Market Strategy Update
By Vaughn Woods
Pandemic, Panic, Trajectory and Strategy
The sum of panic selling appears to have abated. That doesn’t suggest the selling pressure is over, just the panic part. A secondary phase of grinding lower could yet develop and if it does it may occur sometime toward the end of May or into June.
Fortunately, going into this perfect storm we were well positioned with cash, gold and short-term bond holdings. I give myself an A for not listening to those who wanted me to be more aggressive leading up to the decline. School is still out on what grade I deserve for managing the recovery. An experienced portfolio manager can mitigate the downside risk of a recessionary market. Pray for those who are trying to manage this downturn with little or no experience. For those who went into this downturn with significant cash and cash equivalents the strategy is the prudent redeployment of capital. Otherwise the slow boat to recoupment is a buy and hold strategy.
We Live in Volatile Times
How volatile? To illustrate, the market collapse that just occurred took place in the shortest event timeframe in market history. Even Warren Buffet is paraphrased to have said, “It took living to 89 to witness such an event.” Veteran traders, at one point, had to stand aside and gawk at the speed and depth of the decline. Thereafter, a massive short squeeze developed, causing the market to vault higher, up some 50% off the lows. This was the largest one-week advance in over four decades. The 50% retracement off the bottom facilitated cutting losses and adding to cash. In many advisory accounts, we sold three quality companies which raised our cash, expanding our capacity to take advantage of weaker prices further along in the pending recession. This should significantly shorten our time to full recoupment.
Is it Wise to Raise More Cash Now?
Answer: Yes. We’ve done so. Who can solve the question of how much market discounting is appropriate for a future that includes the ripple effects of: the pandemic work stoppage, 22 million American job losses, if, when or where a second wave in coronavirus cases bubbles up, a doubling of the federal debt, $20 trillion of wealth destruction worldwide, public “virus-management” efficiencies, implications as to presidential politics, small businesses loan funding vs. true liquidity needs, recession duration, changes in human behavior post crisis, and the effectiveness of the larger health care system in testing, tracking and treating the public.
Credit Suisse now estimates this upcoming recession will last “just” 12 quarters, 36 months. I hope they’re wrong. As of today, the stock market is discounting a much shorter time to recovery. However, at this early stage of the economic cycle, every daily point of value on the S&P 500 and every upward-trending rally below the 200-day of S&P 500 vividly attests to a recessionary grind. Technically speaking, this will continue to be the case until the S&P 500 as measured by the 50 day-day moving average crosses back above its 200-day moving average for a time. Anyone who wants to overweight risk-taking now before the recession takes hold is taking on far more risk than is necessary, and that folks, is the individual adrift in a 100% buy-and-hold strategy.
Understanding Recovery Cycles
While Credit Suisse may be estimating a 36-month recession, I do agree with those who believe a shorter recession is coming. Here’s why: The Federal Reserve moved quickly to shore up the economy with monetary and fiscal stimulus supports. Congress moved faster than normal to supply much needed funding to large businesses. Therefore, my guess is the recovery will be well underway within 24 months.
Implications? The number of months to the bottom of a recessionary stock market often lasts no more than half to two thirds of the recession itself. To illustrate, the dot.com meltdown recession followed by 9/11 lasted some 36 months but hit bottom 22 months into the ordeal. Moreover, the great recession of 2007-2010 lasted some 36 months. It bottomed 17 months after starting. That was March of 2009. So, to benefit from dry powder (cash) investors must do two things. 1. Participate early in the recovery. 2. Don’t dollar cost average on the descent. This is where economic cycle experience holds exceptional value.
The covid-19 pending recession
So, to review the current covid-19 recession, as of February 19, 2020, the S&P 500 hit an intra-day high of 3393.52. Twenty-three trading days later the market bottomed at 2191.86 or a decline of 35.4%. Some people think if the S&P 500 advanced 35.4% at that point, they would recoup their losses; however, it takes a return of nearly 55% to recoup a 35.4% drop. To put that in perspective, it would take a return of 4.5% per annum for ten years to recover to the recent high. Fortunately, after the recent retracement of 50% off the bottom, what some refer to as a bear market rally, a large portion of the recovery necessary to recoup the recent drop has already happened.
So, what can we to learn? Answer: the market goes through phases in a recession. The first phase is panic selling. The second phase can be a monster rally or rallies as short sellers are getting out and value buyers are stepping in to buy simultaneously. Check that box. A grinding higher is what we are witnessing now, though valuation concerns should soon reappear, causing the market to grind lower. This phase often includes all hope lost. We shall see. If we go through this phase it may be due to a rebound in pandemic cases later this fall or winter.
For now, relative optimism is being infused within the early shutdown as it appears the government is throwing trillions at the problem just as testing, tracking and treating solutions are being introduced. Nevertheless, it’s difficult to imagine we will make it through the summer months without additional market setbacks and possible retests of the lows. There are three reasons optimism may hold the markets up in the short-term: money on the sidelines is monstrously large, institutional investors and pension funds must rebalance their portfolios into stocks according to asset allocation requirements, and short seller holdings are the highest since 2016 according to the Wall Street Journal. To take a profit the short sellers need to buy the stocks they’ve shorted.
As to worst-case scenarios, rather than going into each, let me simply say we have considered many strategies, inclusive of slides to 1700 on the S&P and lower. The Federal Reserve is whispered to be willing to step in to support the stock market below 1700. While it may seem unthinkable, governments stepping in to support equities is not unheard of in modern times. The Japanese have done so recently and effectively.
As to dividends, there is much talk about corporations being forced to lower or suspend dividends and/or cease company stock buybacks. However, companies with sufficient capital on several measures should be slow to consider cutting dividends. A prudent strategy would be to wait several quarters before negating the loyalty of their shareholder base. Meanwhile, the shares of many companies have been discounted sufficiently to assume a dividend cut. This discounting does not a dividend cut make. Not all companies will reduce or stop their dividends. Moreover, companies that continue to earn and maintain their dividends for stockholders throughout the recession will be richly rewarded with higher earnings multiples later.
Since World War II, the U.S. has had 13 recessions. Every rebound has been born of a residential real estate boom and an ensuing stock-market recovery, the result of both fiscal and monetary stimulus. This brings us to consider the best time to invest. The average return in the first twelve months of a new post-recession recovery for stocks is roughly 48%. After the last recession, the post-recession period witnessed a market rebound over 56% in the first twelve months of the new economic cycle. While there is no assurance such trends will hold in the next post-recession period, these post-recession years do have similarities; expanding earnings are subject to easy comparisons quarter-to-quarter. Therefore, by illustration, if the current market drops an additional 20% and thereafter, we are fortunate enough to participate in just 75% of the average post-recession recovery returns, accounts should advance approximately 22% above current levels.
As for now, the fear of missing out on market rallies (above the S&P 200-day moving average) is dead. Far too much technical damage has been done of late to bring back investor confidence. That will take time. For now, staying abreast of news showing the pandemic is being tamed is the order of the day.
We are now in watch of a time to prudently redeploy capital. This should be the best time to invest since post-recession recoveries represent little downside and years of upside. As we approach a new recovery, new industry leaders will emerge, as will the major industry groups that first entered the recessionary downturn. Historically, they have been the first to emerge during the recovery. We’ll be watching. Patience, prudence, action, assessment and reassessment. It’s what we do.
Stay safe and remain hopeful. Thank you for helping your neighbors in need and thank you for your continued faith and trust in what we do on your behalf. Please call or email with any questions.
Vaughn Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De la Playa
La Jolla, CA 92037
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided her is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0247.