As the following performance data of the S&P 500 attests, the recent rally in stock prices has been a gift!
Three events account for the S&P 500’s spectacular recovery.
1. Massive fiscal and monetary support for credit markets, companies and the economy.
2. Hope for the continued progress in taming the coronavirus pandemic, especially the prospect of reopening the economy and potentially viable drug therapies.
3. Fear of Missing Out (FOMO, for short).
We say the recent rally was a gift because market prices have been partially reset. Stocks have now only experienced what is technically defined as a “correction” (down 10-20%) versus that of a “bear market” (down 20%+). What was truly a nightmare is now just a bad dream. But is the worst really behind us?
Fiscal and monetary policy legitimately have our attention here at NWCM. There’s good reason Wall Street has always said, “Don’t fight the Fed!” Such stimulus proved effective 11 years ago during the Financial Crisis. However, we would like to see some fiscal spending directed to infrastructure. Job creation is paramount.
We prefer hope to be supported by convincing empirical evidence as we are operating in uncharted territory. No one really knows what the virus has in store for us. Will there be a second wave of infections? Will there be testing to adequately trace the spread? Will drug therapies arrive to minimize the severity and length of the illness? And when will we see a vaccine?
FOMO is a legitimate reason NOT to sell into the teeth of a bear market because when the market bottoms and bounces, investors do not want to miss out. However, FOMO is NOT a reason to chase this rally. Is it really possible that after the global economy dropped to its knees, the economy can jump back as stunningly as the S&P 500 has come back in a few short weeks? Is the financial calamity that tens of millions of our citizens have suffered so easily washed away without any lingering effects?
We believe the markets are at the proverbial “fork in the road.” If the recent progress in drug therapies continues, and the forthcoming re-opening of the economy is successful, the market lows for this crisis were probably reached in March. In that scenario, we would still anticipate volatile market swings of 10-15% as health, economic data and corporate earnings are reported over the coming weeks and months. However, the combination of current Federal Reserve support, the degree of stimulus already in place, and successful progress against the pandemic would likely lead to further gains in the market as we head into the second half of 2020. We all hope this scenario becomes our waking reality!
However, if an alternative scenario were to develop, the market could go substantially lower. Disappointing news concerning any of the following may trigger other, less favorable outcomes:
Failure over the next 2-3 months to create and source viable drug therapies that mitigate the death rate from the coronavirus;
Second quarter corporate earnings—the first full quarter of earnings since the pandemic started—come in significantly worse than forecasted;
A substantial uptick in defaults by companies servicing their debts; and/or,
The decision to reopen the economy proves to be premature (heaven forbid!) resulting in another spike of infections and deaths—and necessitating another round of “stay at home” quarantine.
If any one of the alternate scenarios were to materialize, we would not be surprised if the markets pulled back by a significant amount—perhaps wiping out all the gains we have enjoyed since the March low.
Still, we are optimistic on the prospect that stock prices will be higher in the years to come. Our consternation is over the short-term: what happens in the next few weeks and months?
NWCM does not have a crystal ball. We can only hold to our established discipline. We are looking at all Client portfolios and, where deemed appropriate, we are modestly trimming back stock exposure (2-6%) on the heels of last month’s strong rally. This will place some cash funds in reserve, available to reinvest in stocks should the markets retest their lows—or serve as a buffer to wait out a protracted economic recovery. Either alternative is a possibility.
We have asked Clients to participate in this exercise by using this recent rally in stock prices as an opportunity for each to reevaluate their risk tolerance. How much cash reserves do you have at your bank? Review your current and longer-term spending needs. How confident are you in the stability and continuance of your earned income? In short, ensure you have adequate savings to meet your spending needs in the event this crisis drags on longer than we are all hoping.
Our clients are encouraged to share their thoughts on their portfolios’ appropriate stock exposure. If they determine their stock allocations need to be trimmed more significantly to accommodate personal circumstances, they need not be Fearful Of Missing Out. Sufficient stock exposure can prudently remain in their portfolios so they participate meaningfully in any longer-term, sustainable recovery.
We hope you and your families remain safe and healthy during these challenging times.