There is no sugar coating. This was a bad week for stock investors, whereas bond investors had one of the better weeks in history. It set all kinds of records for bad. It was the worst week for the Stock Market since the Financial Crisis in 2008. The S&P went from all-time highs to a 15% decline in just seven trading days. It erased four months of gains faster than ever before. Thursday was the worst price decline ever on the Dow Jones Industrial Average. That sounds worse than it is. It was just the 125th worst daily percentage decline. Thursday’s 4.4% drop in the S&P 500 was the worst one-day decline since 2011 but was just the 106th worst day on record.
Things are way, way oversold right now. Panic set in and volatility has spiked. Markets do this, we know this. It’s never fun. Fear reigns supreme right now. The volatility index (VIX) approached 50 this week. The last time it reached this level was at the Market bottom in February of 2018. It was at 13 just two weeks ago. Fundamentals have taken a backseat for a while. Technicals are more helpful, but at this stage, things need to take their course. People seldom make their best decisions when they are panicking. Part of the problem right now is that people are not triggering the sales. Programmed trading accounts for 80% of volume today. The machines are triggering the volatility. Over-levered hedge funds most likely have significantly influenced the 15% decline in just seven days’ time. The percentage of stocks that are internally oversold in the S&P 500 is now the 4th highest since 1957. This is historic oversold territory. This week was a statistical anomaly. It’s that extreme. It’s in this type of environment where the Market moves at lightning speed. The daily Dow movements were hundreds of points within minutes, if not seconds. Pretty much everything outside of Gold got hit, and even the precious metal ultimately fell victim to liquidation. True price discovery is nearly impossible at that point. It’s such a fast-moving Market.
The Bond Market has been signaling trouble for a while. Interest rates keep hitting all-time lows, with the 10-Year Treasury yield at a mere 1.1% and the 30-Year at 1.6%. It’s been great for bond investors. The slowdown is accelerating. China’s GDP might contract in Q1. The US will certainly slow. The Global Economy is now slated to grow less than 3%, the lowest in a decade. There is no doubt this sell-off and economic decline will have an impact on the Presidential election. The race seems to be widening a bit and the Market will be paying very close attention. President Trump has been leaning hard on a strong US Economy and Stock Market. Senator Sanders has eyes on Wall Street as well, but with a different lens. A strong showing in South Carolina from Vice President Biden could shake things up a bit too, reviving his campaign while the Bloomberg burst seems to have reversed. There’s also the Fed, which has artificially propped up asset prices since September. The Bond Market keeps forcing the Fed’s hand, with the probability now 100% of a ¼ point cut at the March meeting and a 71% chance of it being a ½ point cut.
We don’t profess to have any expertise on the coronavirus. Our job is to interpret developments and make decisions based on what it means for the Market and what it means to the businesses that we own in our portfolios. The problem is, there is very little information out there as to the state of the outbreak and the ability for containment. Regions in China have been in lockdown. Japan is closing down schools. The Olympics are at risk. The virus has spread to Europe, the Middle East as well as the Americas. It’s spread to Northern California. Fear has spread throughout the globe. What we do know is economic growth is going to be impacted. It’s going to slow. Corporate earnings will slow too. We already thought the Street estimates were way too high. The Street is always late to cut. They’re doing it now. The only question is how low. The question is unanswerable at this point.
As investors, we are owners of businesses. Companies were over-valued and might still be. In fact, despite the sell-off, some stocks might be more expensive today than a week ago. It all depends on the E (Earnings). This much we know: Apple is going to sell fewer iPhones than expected this year. Disney is going to have less traffic in its theme parks. Starbucks will sell less coffee and other items. But we believe it will prove temporary. The only question is how long. Their stocks were ahead of themselves, much like the overall Market. But these are businesses that are strong and sustainable. Businesses and assets have always experienced over-valuation throughout the centuries. I am reminded of Pebble Beach and the purchase by a Japanese investor three decades ago at a record price only to see a forced sale at a massive loss just a few years later. Pebble Beach is a crown jewel in California. But price matters. Even the highest quality asset is not immune.
Price discovery is a natural thing with free markets. Matching buyers with sellers is the best way to create a fair price. Confidence matters. Sometimes confidence is too high. Other times it’s too low. Confidence was way too high, if not downright euphoric the last few months. There’s nothing like price to change sentiment. A week ago, the herd was the most bullish it’s been in a couple of years. Today, it’s the most bearish. Generally, the best decisions come against the herd mentality. Warren Buffett has always said to be fearful when others are greedy and vice versa. British banker Baron Rothschild was known for saying “buy when there’s blood in the streets.”
We have been positioned defensively for months and have been saying that the Stock Market had no business racing higher. We’ve referred to the move higher since September as a reckless rally. It was led by just a handful of Tech stocks plus Utilities. It was not broad-based. It was not healthy. It was enticing people to chase momentum higher, and they got burned. Just last week, I highlighted a headline suggesting investor euphoria was back, similar to the Dotcom days. That didn’t last long. It rarely does. The panic should have come because of the excessive rally. It was panic buying. The media never covers that. It was very excessive. The sell-off is merely correcting the excess. Calm, logical and informed decision making always wins out over time.
The bottom line is this: This Market was way, way overdue for a correction. The coronavirus has been the catalyst. The problem now is, from a Market standpoint, it is completely unknowable how bad the impact will be. Just like stocks overshot the upside, they tend to overshoot the downside as well before recovering. We experienced it not that long ago, with the Christmas Massacre in 2018. There’s been a lot of damage this week to the Stock Market. We believe the conditions for a counter-trend rally are setting up as the “Bad News” is at a very high fever pitch. We took off most of our hedges this week, as the risk has been realized to a large extent on the short run. But we aren’t convinced yet that the ultimate lows are in. We are looking for a healthy bounce that probably comes as early as next week We will likely get more defensive and redeploy our hedges then. We expect a lot of choppy price action for a while. These situations take time, and true price discovery can be a process. That is particularly true when dealing with an issue like this virus outbreak, where the outcome is unknowable.
We are on it, and are hyper-focused on protecting your life savings.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
