April Market Note

April 21, 2020 | Brad Griswold, Managing Partner

This isn’t our first rodeo. We have been through a number of market cycles, but this one, while having some similarities to ones in the past, has its own unique set of conditions and potential outcomes. However, in every bear market the key to coming out on the other side is the ability to maintain the proper perspective. Bear markets are an example of destructive capitalism. Periodically it is necessary to hit the reset button. It can be painful; however, the duration is limited in both time and scope and on the other side is recovery.

Our job, during these periods is to provide an objective long-term perspective. It is too early to quantify the damage of effectively shutting down the economy and when we get our feet back under us. But we will, it is just a question of time.

Economic Recovery: V, U, L, W, Square Root?

We are patiently optimistic.

At present, we are seeing some improvement in the number of new cases, possible treatments, and the introduction of a framework for reopening our economy in stages. All of this is good news, but how much damage has been done to the economy already and are the markets correctly pricing in this damage? Our guess is no. We fully expect volatility in the markets to continue.

The markets are pricing in a V shaped recovery, but for that to occur the economy may need to fully reopen by the end of May, the number of new cases need to decline precipitously, effective treatments need to be developed prior to September, and more importantly we need to avoid a reoccurrence in the fall. That’s a pretty tall order, but possible.

A more likely outcome is a gradual opening of the economy, certain protocols are maintained such as social distancing, which negatively affects the economic recovery, treatments have some success and the smartest minds in the world continue to work on a vaccine, but it will not be ready for widespread distribution for at best, months. We avoid a significant uptick in new cases and the recovery looks more like an elongated U. In other words, the economy could take several quarters to stabilize prior to a sustainable economic recovery.

Is the worst over?

The markets have retraced 50% of their losses in a matter of weeks, is this rally sustainable or a bear market trap?

Everyone has an opinion and to some degree everyone is probably wrong. Over thirty years of managing money we can’t count the number of times the markets have acted irrationality in the short-term. The only saving grace is that over a longer time period the markets do in fact act rationally. In our humble opinion the first rally off the bottom is for traders and we will at a minimum come close to retesting the lows in the weeks and months to follow.

Economic reports have been absolutely horrendous providing a first indication as to the devastation the shutdown has caused to the economy.  Corporate earnings season is beginning this week with a vengeance. What companies report and more importantly what they indicate about the future could tell us a lot. Unfortunately, I don’t think they have any better idea than the rest of us and will leave investors frustrated with a lack of conviction one way or another. 

More importantly, valuations have in all likelihood increased during the market sell-off.  It may be counter intuitive to believe stock valuations could be higher at this point, but the reality is company earnings have probably fallen faster than stock prices pushing up P\Es.  Valuations need to fall further on a comparative historical basis to equate to fair value and bear markets usually end with stocks trading below fair value.

So, no we’re not out of the woods.

Straight roads are for fast cars; turns are for great drivers.

The speed at which the financial markets are moving is unprecedented, but not unexpected. With the advent of computer driven trading, market cycles have become compressed. Information is now disseminated at such speed that investors assume they no longer have the luxury of making thoughtful decisions. They are forced to react quickly, or they will be left behind.   Actually, that depends. Are you a trader or an investor?

If an individual is attempting to trade a market, they are forced to make three correct decisions in a very short period of time. What to buy, at what price, and most importantly when to sell. Get one of these wrong and your probability of success is limited. In addition, consider the competition in this environment. Private Banks, Hedge Funds, and Institutions are using algorithms supported by artificial intelligence, to analyze news and a million interconnected data points in Nano seconds. And even then, they don’t always get it right. Too many variables for our liking.

Forget fast cars instead be a great driver.

Investors unlike traders have a different mindset. They have carefully considered and identified their objectives, defined their tolerance for risk, and they have determined their time horizon to accomplish their goals. In this environment they should be focused on buying great companies at or below fair value. Forget about trying to make a quick buck, be a great driver. Take advantage of the straightaways, but always be ready to accelerate into the turns.

Buy the Dip?

Today individuals and investment professionals are in the thick of it. For many, they have just experienced their first material bear market and the first leg down was over before many knew what hit them. However, just like in Pavlov’s experiment they have been well trained to buy any and all dips. You see for over ten years the markets have traded on monetary policy rather than fundamentals contributing to one of the longest bull markets in history. It has also conditioned investors and professionals to buy the dips. The formula is pretty straight forward.

(Catalyst) Stocks go down = (Action) Federal Reserve prints money = (Result) Stocks go up

But will it work this time? We have our doubts; unfortunately, it is the only kind of market many of them know.

Hindsight is 20/20

When the year began, we thought the markets were overvalued and due for a correction. Our assumption was earnings would come in light, valuations would be called into question, and the market would trade down 10% or so and then stabilize. A contentious presidential cycle would add to the volatility, but after all the shouting was over the stock market would end the year with single digits gains and interest rates would finish slightly higher.

If only.

Hope is not a strategy

We hope the virus is contained. We hope effective treatments are found. We hope a vaccine is created to eradicate this strain. However, we do not recommend basing your portfolio decisions on hope, but rather a careful analysis of possible outcomes and the probability of each. Until we can answer these questions, we cannot determine the economic impact. Decisions should not be made in a vacuum; we will need good data to make good decisions, but at some point, decisions will need to be made with incomplete data. This is where experience plays a role.

Final Thoughts

As they say, they don’t ring a bell at the top or the bottom, but over various bear markets we have experienced similar reactions among investors that can assist in determining where we are in the cycle.

The bear market will not be over as long as everyone keeps asking what they should buy.  When everyone asks if there is anything left to sell, we’ll be getting close to the end.

When people talk about the rate on their CDs in the checkout line at the grocery store, we’re probably there.

When people tell you about their recent trip, but don’t know the log in for their 401k account we’re probably in a bull market.

If we are correct, the markets will trade down in the coming weeks and months.  Rather than attempt to time the markets, we will be patient and allocate capital when we believe there is a lasting opportunity as investors.  In all probability the markets will have declined significantly from the highs at that point, but that is exactly when we should buy, when it’s uncomfortable. 

Managing risk equates to hedging the downside and being patient.   Fortunately, we are in a position to capitalize on both.

* Opinion piece, please see Important Disclosure