Equities Q1 2020

In the U.S., the S&P 500 Index (price plus dividends) declined 19.6% in the first quarter, and 24% from the February 19th high of 3,394. Outside the U.S., global stock prices, as measured by the MSCI All Country Worldwide Ex-U.S. Index, declined 23.3%.

Recent stock price gyrations are nearly unprecedented, with the depth of the U.S. sell-off in such a short period of time ranking the worst on record, punctuated by equally staggering one-day “relief rallies.” That said, recessions and market meltdowns have occurred many times throughout history, so in some ways this time is no different. This is not an attempt to either surprise you or downplay the current situation, but rather to highlight two key points.

First, while the exact circumstances of the COVID-19 pandemic place us in uncharted waters, this is certainly not the first time people, governments, and financial markets have faced extreme challenges.

Second, the history of market declines indicates that markets have recovered 100% of the time, rewarding investors who bought on weakness, or simply did not sell at times when uncertainty was highest. As the charts below display, patience has been and always will be, an investor’s best friend.

The near-term outlook for stocks is uncertain as visibility into both the depth and duration of the economic downturn remains low. The situation is evolving every day, with the “knock-on” effect of each closure, headline and data point discounted by investors in a variety of ways. The result is strikingly different expectations for future economic growth and corporate profit trends amidst the present COVID-19 fallout. This leads to volatile market moves as current stock prices represent investors’ best “guesstimates” of the present value of stocks’ future cash flows. When those cash flows are threatened because businesses experience a drop in revenues and earnings, stock prices drop. As confirmed coronavirus cases continue to mount, we would not be surprised to see market volatility continue.

From a longer-term perspective, our outlook for stocks is constructive and our conviction is high. As displayed below, if one uses history as a guide, the markets will recover. Economic activity will begin to stabilize and then improve as the tide turns in the battle against COVID-19. Buyers are beginning to return to the market and we have already had days where stocks were in positive territory by the closing bell.

In recent weeks, individual stock price movements have been highly correlated to one another relative to history, rivaling levels seen in the Great Depression and Financial Crisis. This suggests investors were simply and indiscriminately selling stocks as an asset class, with little regard for the underlying fundamentals of those companies. Furthermore, mutual fund and ETF holders selling their shares exacerbate this indiscriminate selling. As the dust settles, we are likely to see valuations return to levels reflecting company fundamentals. But valuations of stocks in sectors of the economy severely affected by the virus (e.g. hospitality, travel, dining) may remain depressed for a while.

However, the market has always been a leading indicator. Stock prices will begin to recover lost ground before Main Street begins to see signs of progress. Using China as a recent example (though there are countless other analogies going back to other “bad news” events in history), its stock market bottomed around the same time that new cases of COVID-19 peaked. As hopeless as the current situation sometimes feels, it will not last forever.

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