Market volatility is back, big time. The S&P has experienced six 3% daily moves, both up and down, in the last two weeks. This type of price action had not occurred in the previous 24 months. In fact, the volatile price action this week, which saw a 2.5% move each day, had only happened before during the Financial Crisis in 2008 and twice during the Great Depression in 1929 and 1933. It’s been gut-wrenching. Today we ended that streak with a late-day rally to close well off the lows. It’s no wonder you feel shaken. You’re not alone. As stated last week, we anticipated a sell-off for some time. In fact, we didn’t understand the end of year rally into the new year. It didn’t make any sense. The Bond Market had been telling a much different story than the Stock Market for months. Importantly, when we refer to the Market, we mean the totality of stocks, bonds, commodities, currencies, etc. They’re all, to a large extent, intertwined. We always view the Bond Market as the smartest.
It makes you wonder with all the negative news and events, how could the Stock Market have possibly gone up so much earlier in the week? There were two 1,000 point gainers on the Dow this week. By the end of the week, the gains were largely erased. Bear Markets do this. There have been 276 one-day rallies of at least 3% in the S&P 500 going back to 1928. 136 have come during Bull Markets, 136 have come during Bear Markets, and two aren’t clear because they happened this week. We think Bear. You never really know until you’re in it, but it is shaping up as if we entered a cyclical Bear Market in January 2018 and saw a blow-off top in Q4 2019, which spilled into the new year, before getting clobbered in February. The coronavirus was simply the catalyst. Growth was already slowing. Trouble was already brewing. It’s just gotten a whole lot worse. The problem is, there is no end in sight. Earnings and economic growth are stalling. Forecasters are blind. Travel and leisure have come to a screeching halt. The US Economy is 70% Consumer spending. The American Consumer is concerned, and rightly so. Economic activity is going to slow, there is no question about that. The question is how much and for how long.
The coronavirus is the focus, but the Bond Market is the barometer. Interest rates keep sliding, with the 10-Year Treasury yield hitting an unprecedented 0.66% level. The 30-Year hit 1.20% (for reference in 2018, it was well above 3%). This is extreme. Real interest rates (when subtracting inflation) keep sliding further into negative territory. The VIX (volatility index) hit 50. That speaks to extreme caution and things are not healthy. Money keeps flowing to safety, which has mostly been Bonds and Gold.
The Fed made an emergency interest rate cut this week. The Market was not impressed and is saying it is not enough. The Bond Market is increasing its bet that the Fed will follow this week’s surprise 50-basis point rate cut with more easing – at or before its scheduled March 18 meeting. The Market now assigns another 100% probability of further cuts, with a 64.9% probability of a 75 basis point cut, taking the overnight rate to just 0.5%. The headline that rallied the Market into the close was the hint Fed Presidents made in regards to potentially buying Stocks. Yes, you read that correctly. Quantitative easing out of the financial crisis was when the Fed purchased Bonds to keep a lid on rates and entice risk-taking in other areas to stimulate growth. Well, the potential or hint of the Fed buying stocks just took Quantitative easing to unprecedented levels.
The February job report showed 273K jobs were created, significantly beating expectations. The unemployment rate is back down to the 5-decade low of 3.5%. December and January numbers were revised higher. Labor has been a solid element of the US Economy all along. However, this is all in the rearview mirror, and the Market only cares what’s going to happen ahead.
Heading into 2020, we expected the earnings and economic slowdown to continue, but a recession didn’t seem likely until 2021. The coronavirus has been a shock to the global system, and the Market is now going a long way into pricing in a recession this year. As you know, the Market is forward-looking. How much has been priced in is anyone’s guess. The Stock Market historically takes the escalator up and the elevator down. That has certainly been the case of late. We continue to use defense mechanisms to combat the stock sell-off with various hedges. We have raised substantial cash. Bonds are thriving. Gold is thriving. Owning a stock is investing in a business. We own so many high-quality businesses right now that are experiencing a re-set in valuation as the Market tries to find price discovery. It’s a process. The process almost always overshoots on the way up and the way down.
Investing is a journey. This is a massive storm that requires battening down the hatches. That’s what our hedges do. We are navigating a very difficult and treacherous stretch of this cycle. We will get through it just fine. We know it’s not over and will continue to act and communicate throughout this journey together. We’ve got this.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
P.S. With the steep decline in interest rates, money keeps getting cheaper. If you have a mortgage, you might consider refinancing. A 30-Year mortgage rate is the lowest it’s ever been, near 3%.
