Hello all – we hope you had a nice February.
We sure are glad to put this month behind us. A sharp drop late in the month sent the market to levels we first saw in September of 2018. For the month, the Dow was off 10.5%, the S&P fell a little more than 9%, and the Nasdaq lost 7.6%. It was the worst month since 2008.
We sure are glad to put this month behind us. A sharp drop late in the month sent the market to levels we first saw in September of 2018. For the month, the Dow was off 10.5%, the S&P fell a little more than 9%, and the Nasdaq lost 7.6%. It was the worst month since 2008.
The selloff has been so sharp that it marked the fastest 10% decline on record.
However, investors with a large allocation to bonds have fared better since bonds prices are at or near record highs. Bond yields are at their lowest level in history, which is really remarkable (bond prices go up when yields go down).
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What’s behind this selloff? The Coronavirus is the main culprit, but there’s also a couple other factors at play.
Before getting to the Coronavirus, we’ll start with the trading environment.
The vast majority of trading in the market (like, upwards of 80%) is computerized trading, where algorithms place trades when certain conditions are met (for example – sell when a stock or market hits its 200-day moving average).
All these algorithms (or “algos” as they’re often called) tend to have similar strategies, so when a trigger is met (like the 200-day average example, from above), they all tend to sell. This exacerbates the problem and causes a larger selloff than we’d ordinarily see.
Also, we can’t underestimate the importance of free trading. Since it costs nothing to place a trade these days, more and more people are active in the market and the herd effect becomes greater. Selling begets more selling and it snowballs into a free-fall, like we have just seen.
We believe these factors have made the drop worse than it otherwise would have been (and you can argue the same circumstances pushed the markets too high, too).
Before getting to the Coronavirus, we’ll start with the trading environment.
The vast majority of trading in the market (like, upwards of 80%) is computerized trading, where algorithms place trades when certain conditions are met (for example – sell when a stock or market hits its 200-day moving average).
All these algorithms (or “algos” as they’re often called) tend to have similar strategies, so when a trigger is met (like the 200-day average example, from above), they all tend to sell. This exacerbates the problem and causes a larger selloff than we’d ordinarily see.
Also, we can’t underestimate the importance of free trading. Since it costs nothing to place a trade these days, more and more people are active in the market and the herd effect becomes greater. Selling begets more selling and it snowballs into a free-fall, like we have just seen.
We believe these factors have made the drop worse than it otherwise would have been (and you can argue the same circumstances pushed the markets too high, too).
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As for the Coronavirus, it made its first appearance in January and caused a little rattle in the markets. As time went on and more cases were reported, the lower the market went.
It may not be the most severe virus we’ve ever seen, but the reaction has been significant.
Things like business and factory closings will obviously have an impact on the economy, especially by causing disruptions in the supply chain. How big an effect remains to be seen, but estimates for earnings and economic growth have been sharply reduced.
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With the forecast for weaker economic growth, there have been more calls for the Fed and other central banks around the world to increase their stimulus.
In fact, the market is pricing in an 80% chance of four interest rate cuts this year (lower interest rates make it cheaper and easier to borrow money).
We aren’t sure how much an increase in stimulus would help the situation, but it shows how far the central banks have strayed from their original role as lender of last resort.
This economic downturn isn’t because of a lack of demand, where the Fed would stimulate the economy to make it grow. Borrowing costs aren’t so high that businesses can’t borrow (interest rates are already at record lows). The only thing the Fed can do here is give a boost to the stock market, which is far outside their mandate. And it does nothing to fix the underlying problem.
This economic downturn isn’t because of a lack of demand, where the Fed would stimulate the economy to make it grow. Borrowing costs aren’t so high that businesses can’t borrow (interest rates are already at record lows). The only thing the Fed can do here is give a boost to the stock market, which is far outside their mandate. And it does nothing to fix the underlying problem.
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Speaking of the Fed, we believe they contributed to the fall in the market, though we have not seen it reported anywhere.
Their stimulus program over the last decade was to print money to buy bonds and cause the markets to rise. They paused this program in 2015, only to recently restart it last fall – which we believe was a major factor in the market’s rise since then. The gain since October is clearly visible.
However, they appear to have stalled the program again. Their balance sheet has been pretty flat in 2020 and we just had the first two-week decline in their balance sheet.
We think the rollback in this program has contributed to the market volatility.
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The last factor in the recent market decline has been the emergence of Bernie Sanders as the frontrunner in the Democrat primary.
Exactly how large an impact is up for debate, but the fact that the banking and healthcare sectors have fared worse than the broader market during this decline is a sign of his impact (he wants to break up the banks and take over the healthcare industry).
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We won’t get into the economic data points of the month like we usually do since they are largely irrelevant at this point. Economic reports were solid overall before the virus appeared, but we can count on the upcoming releases to being sharply lower as a result.
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Where does the market go from here?
At present, everything is strongly oversold on a short term basis (meaning they are attractive for investment). When to get in remains the question. Sharp declines like the one we’ve just had tend to have sharp rebounds, but we aren’t trying to catch a falling knife. We’d like to see a strong day higher with a lot of volume before dipping a toe in, then add more if conditions warrant.
As mentioned above, we will hear about lower economic growth and corporate earnings for at least the first quarter and this will contribute to the volatility.
Remember, though, that the time to buy is when others are fearful.
A useful contrarian indicator comes from CNBC. The times when the business channel reports that the “markets are in turmoil” has turned out to be a smart time to buy. For what it’s worth, they’ve said this every day this week.
At present, everything is strongly oversold on a short term basis (meaning they are attractive for investment). When to get in remains the question. Sharp declines like the one we’ve just had tend to have sharp rebounds, but we aren’t trying to catch a falling knife. We’d like to see a strong day higher with a lot of volume before dipping a toe in, then add more if conditions warrant.
As mentioned above, we will hear about lower economic growth and corporate earnings for at least the first quarter and this will contribute to the volatility.
Remember, though, that the time to buy is when others are fearful.
A useful contrarian indicator comes from CNBC. The times when the business channel reports that the “markets are in turmoil” has turned out to be a smart time to buy. For what it’s worth, they’ve said this every day this week.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
