By now, you have likely heard in the media or through conversations with friends and family of the recent market volatility experienced the week of February 24th -28th.
What a difference a week makes. It was a wonderful (and unexpected) upswing from Jan 1st until Feb 21st. This week the market gave all of those gains back and then some, with the Dow Jones Industrial Average down 11.2% on the year, S&P500 down 8.95%, the TSX down 5% and the MSCI EAFE Index down 11.5%. In times of extreme market volatility, I have always believed that context and history are vital in providing insight to guide us. Many in the media and even some in the investment world are speaking of this in terms of financial Ar-mageddon. To say that this kind of market behaviour is unprecedented is A LIE!
Yes, Thursday’s trading resulted in the largest point loss in history of 1190 points on the Dow Jones Industrial Average (DJIA); however, I believe the percentage loss is a more important measure. From a percentage loss standpoint, September 29th 2008 resulted in a 6.98% loss and February 5th 2018 resulted in a 4.60% loss; Thursday’s loss was 4.42%. It is also important to note that when the markets hit higher highs, as they had until Thursday last week, the one day mega losses seem to be all that much larger.
The chart below provides some context in terms of days where “all seemed lost” only to result in either next day gains or next month gains to overcome previous losses. It is important to note that the single largest percentage gains occurred during the financial crisis of 2008/2009 in which the DJIA posted double digit percentage gains twice. Arrows on the chart indicate either next day or next month response activity.
It seems volatility will be a reality for 2020. I believe the Covid-19 virus is an excuse the market is using to rebalance the books. Some stocks were FAR too strong in price movement in the 4th quarter of 2019 and the 1st quarter of 2020, and there was some irrationality on the upside. The downside seems to be more violent but we have seen this movie before as the chart above indicates. With that said, this seems like the most appropriate time to remind ourselves (investors in general) that annual rebalancing is not only prudent but optimal, to harvest yesterday’s gains and to sow into yesterday’s laggards. Returns on asset classes are not static and yesterday’s winners are rarely ever tomorrow’s winners.
As a ‘professional investor’ (whatever that means), I must remind myself constantly that I cannot time the markets, I cannot predict the markets, and that my most immediate reactions are not always the best responses to a particular market situation. Perspective shapes response.
I was speaking this past week with both a bond trader and an equity trader with over 30 years of experience who were lamenting the markets to me. I asked them to point on a 20-year chart where the Swine Flu epidemic, the SARS pandemic and the Ebola crisis were. They could not. As a history reminder; Ebola occurred in 2014 in West Africa, SARS (China) occurred between 2003 -2004, and Swine Flu was in 2009. These types of crises tend to provide lots of media attention but they tend to defer economic outcomes; they rarely change them. Yes; there will be economic fallout due to this epidemic/pandemic. Supply chains are being disrupted, and financially unsound companies will suffer. Some good companies may be affected as well. But governments are being quick to act with monetary policy and already talk of lowering interest rates to stimulate the economy are underway. The Bank of China has already lowered interest rates. Chinese workers are beginning to go back to work (willfully or woefully).
Yes, cases in South Korea, Singapore, and Iran are rising, and the rest of the world is seeing an increase in cases also as the virus gets disseminated further abroad. Countries are now putting in protective policies and barriers to prevent further spread. What I am intrigued by is the number of recoveries that few in the World Health Organization are pointing to. We are already seeing corpo-rate travel restrictions being put into place due to the virus. Cen-tral banks and governments will soon grease to gears of the econ-omy with tax breaks and lower interest rates to get investors back into risk assets. Lower interest rates spell rising equity markets.
I found it fascinating watching the price of gold go up on Thursday….. and then down. Gold should have gone through the roof IF investors felt that this selling frenzy would be long lasting. The price of gold fell almost $60 dollars on Friday and the NASDAQ market closed UP on Friday (ok, it closed up 0.01% – but still). Instead, I believe that algorithms and computerized trading programs were the culprits this week. And next week, they may be the result of upside swings. A ‘program trade’ occurs when a specific level on an index is breached (downside or upside) and a program begins trading a specific set of investments with a calculated quantity but not a price – in other words, they are sold ‘at the market’ or whatever price the market provides. For example; if the market drops 3% – sell 30% of a specified index. If the market drops another 2% – sell an additional 20% of the index. One program sets off another program, which sets off another program, until all of the program trades are exhausted.
Bond prices rose in anticipation of lowering interest rates…. In the past, market selloffs like we saw this week are countered with a quick 50% rally, a period of some volatility, and then a gradual return in the uptrend. We will have to keep watching. Bank of Canada and the US FED are both expected to announce rate drops with the Fed likely 25-50 basis points. On the equity markets, the Dow Jones Industrial Average closed at 25,409, which brings us back to where it stood in August 2019, just a short while ago.
I have spoken about my opinion (and that is all it is) that I believe that we will see a market correction that has longer term impacts. I do not believe that this is it. I believe for this real correction to occur there needs to be a financial catalyst. What I am watching and listening for is not how the market is performing (up or down) based on coronavirus fear but the impact it is having on financial asset managers and the debt covenants of countries. The world is awash in derivatives (options) and bets on these types of financial instruments can result in wild swings in returns. They can also result in illiquidity – where no one or no firm – wishes to make a market for them. When this happens, there is cause for concern. Governments (EU, USA, China, Developed world) have become very accommodative in taking on additional debt (tomorrow’s problem) to temporarily solve today’s concerns. This can last an inexorably long time (and has).
The table below provides historical results to the S&P500 Index 6 and 12 months after the height of the fear or panic of each epidemic or pandemic. What this does not tell us is why the market index rose, how governments intervened if at all, or how quickly they intervened etc., but it is instructive.
History is NOT a predictor of future events BUT should provide us as investor’s reasonable insight and perspective into what could transpire in coming weeks, months and through the balance of 2020.
To close, I would like to share two things that are vital for me to share in times of market turbulence.
We eat our own cooking:
My personal portfolio, my family and my team invest in all the same investments our clients are invest-ed in. If you are in the same stage of life, with similar risk parameters and investment objectives as I am, your portfolio will look eerily similar to mine.
We believe in the mantra “LILO” Last In, Last Out.
What this means is that we invest our client’s money first before we buy (theoretically, this means that in a rising market, our price would be the highest). Similarly, we sell our clients holdings first before we can sell our own (theoretically, this means that in a falling market, our price would be the lowest).