March 2020
Market Update

“Patience will be required as this plays itself out.” 

Nassim Taleb, in his 2001 book ‘Fooled by Randomness’, described ‘Black Swan Events’ as high-profile, hard-to-predict and rare events that are beyond the realm of normal expectations in history, science, finance, and technology. 

Black Swan Events are named for real-life black swans, which at one time were widely believed to not even exist. Second Century Romans even had a phrase: ‘Rara avis in terris nigroque simillima cygno’, to describe someone or something as so rare or unlikely to exist that it would be like seeing a black swan. Centuries later, however, black swans were discovered to actually exist, in Australia! 

The sudden spread of the Covid-19 coronavirus, and the subsequent worldwide shock that it has produced, has now infected the stock market. Whether this is a true Black Swan event can probably be debated. What we do know is that Thursday, February 27th, was the largest point-drop ever for the Dow 30, although given the lofty levels of the previous high, it’s nowhere among the historical largest percent-drops. 

The S&P 500 and the Nasdaq both set new all-time highs just a week and a day ago (February 19th), and the Dow a week before that (February 12th); but since then, each has lost more than 12% in a cascade of multi-hundred-point down-days. 

The S&P 500 is now back to where we were in mid-October of last year. In the big picture, being set back by four months in the market doesn’t typically raise an eyebrow, as that’s a pretty common occurrence; such corrections have happened dozens of times in history. What makes this time seem different, however, is the speed of the decline ... that’s the argument for a ‘black swan’ event label. 

Thursday was the third day in the last week with a hugely-lopsided down-to-up volume ratio (almost 30:1 Down:Up among S&P 500 stocks on Thursday). Usually, such a tremendously-oversold condition leads to an imminent rally. The most memorable such episode in recent times would be December 24th, 2018 and December 26th, 2018, going from worst-in-a-decade, new Maximum Drawdowns for many investment portfolios, to a months-long steep and unabated run-up commencing the very next market day. That being said, we can’t say exactly how things may play out this time, of course. 

Several of our stock models have a risk-off component, and we have raised some cash going into and through this past week. Given the severity of the markets declines this week, it still probably won’t feel like enough. Rotation decreased stock exposure and added to bonds. The Growth model lightened its exposure to stocks by 20%. The balance of the stock portfolios are still fully invested. 

On the bond side of the equation, we have rotated to cash out of bank loans, high yield bonds and preferred stocks. We haven’t seen that much cash raised in bonds in several years. Typically, bank loans and high yield bonds go out of favor early in the recessionary cycle as they are sensitive to default risk. Are they playing the role of “canary in the coal mine” this time around? Are we on our way into a global recession? 

There will certainly be economic consequences to the massive reaction to this virus. It wouldn’t be imprudent to say an over-reaction. Quarantine of tens of millions of people, companies cancelling travel and schools closing are steps that have been taken that we normally don’t see during a typical flu season, and maybe rightfully so as this isn’t the flu. Yet all of these things and more are part of the daily news and the effects will mean lower productivity, higher costs as companies attempt to outsource products from other countries, lower profits as sales lag and hiring freezes join the news. All these things and more have we already been hearing from our business clients. The end game could very well be a global recession. 

It is our feeling, however, that this recession, if it occurs, will be short and shallow. There will be a vaccine or simply an abatement in the number of cases of the virus. It will run its course at some point, and once that has happened, we will start to see all of the money that the Federal Reserve and the Central Bank in China (and Japan and Europe) have printed make its way into the stock markets. Patience will be required as this plays itself out. 

In the meantime, markets such as these provide clarity on our personal tolerance for risk and if you find you are not sleeping well because the drops in the market have been too upsetting, then it would be fair to say we need to revisit the stock exposure in your portfolio. We encourage your calls and meetings to work together to refine your plan to keep you on track. 

If you have questions, please contact us.

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