Market Update: April 3, 2020

Although it may not feel that way, equity markets have calmed dramatically over the past several trading sessions, with the CBOE Volatility Index (VIX) dropping to the 45-55 range. While still elevated, these levels are a far cry from the March 18 peak of 81, which is important because it signals the initial panic phase of the coronavirus market has ended. If additional hysteria occurs, it will likely be catalyzed by a different impetus. By now, everyone is aware of the severity of the numbers stemming from the virus (in terms of human sickness and death, as well as the economic fallout). Therefore, for further panic to occur, there will have to be a new negative game changer which is not currently on the markets’ radar.

Our recent communications have cautioned against becoming captive to the emotional moment, warning that selling amid market panic is rarely, if ever, a profitable strategy. Now that this recent panic phase has ended, we have the opportunity to assess the current state of things, allowing us to make rational investment decisions decided upon after thoughtful analysis and a careful review of the data.

Here is where we are now after engaging in the preliminary stages of this analysis:

• We continue to monitor our models while staying abreast of potential opportunities. Regarding the latter, we still believe it is too early to take the plunge. While there are certainly tempting assets which have fallen precipitously, the drops have been warranted, and we do not believe the potential reward justifies the potential risk at this point. Meanwhile, our models continue to keep us disciplined, as our equities positions remain firmly in favor of U.S. Large Cap Growth, mostly at the expense of International Markets and, to a lesser degree, U.S. Large Cap Value.
• Much has been made of two assets classes: credit and gold. Our analysis suggests the current credit dislocations pale in magnitude to those of 2008, and, therefore, credit is not poised to deliver the requisite risk-adjusted returns we expect from equities. While this could change with further dislocation in the markets, we believe any investment in credit would be premature at this juncture. As for gold, there are good reasons to be optimistic about the asset class in and of itself. However, relative to equities and their current valuations, the upside is not compelling.
• As horrific as the coronavirus pandemic has been, there is precedent in the 1918 Spanish flu. However, what is unprecedented is the expected economic decline spurred by the current voluntary economic shutdown, leading to a record-fast transition from bumper profits to instant recession. In terms of the recession, many are discussing the possibility of a “V,” a “W,” a “U,” or maybe even an “L” (see graphic below). What we are focused on is how much negativity is priced in given a market decline of ~25% at this point. Our models are already considering the vast quantities of dividend cuts and share buyback suspensions which are continually being announced. Although headlines continue to deteriorate, the decline in market volatility reflects a numbing to the negativity, not dissimilar to what occurs when one repeats a word over and over. Given this phenomenon, market participants will be better able to sift through actual data and potential consequences rather than feeling back footed by grim headlines and market moves which would have seemed unfathomable six weeks ago.
  

• The government continues to fire round after round of ammunition, with this week’s big news being the rollout and onset of the Small Business Administration (SBA) loans to allow companies to keep workers on staff via the Paycheck Protection Program. To that end, we are starting to hear a lot about inflation concerns given the expansion of the Federal Reserve’s balance sheet. We heard these same concerns during the Global Financial Crisis, none of which panned out. In fact, we remain more concerned about deflation than inflation for the foreseeable future.

Lastly, we want to remind everyone that concerted inaction is indeed a form of action. We are consistently monitoring the markets while adhering to the discipline of our models. Please know when no action has been taken, it is by design. As of now, the trajectory of the market continues to parallel what we saw in 1987, which continues to reaffirm that bottoming is a time-consuming process (see graph below). We continue to be thoughtful in assessing all the possibilities, both bullish and bearish, and will be poised to take action when the moment is right.

Source: FactSet