Wow! What a tough couple of weeks! S&P 500 down over 25% peak to trough. Oil stocks have cratered. The USO, which is the US Oil ETF, is down 50% since the beginning of 2020. Here are some of my thoughts about this current situation:
Negative GDP: I believe we are likely to have negative GDP growth. Certainly for March, possibly for the entire 1st quarter, and possibly for the 2nd quarter. Too much of the economy is on hold for there to be positive growth. “Recession” means 2 consecutive quarters of negative GDP growth, and I think that is a real possibility. As a leading economic indicator, stock prices fall as the economy is heading into a recession and recover and point the way upward as the recession bottoms out. The sell-off in stocks we have had for the past few weeks fits the bill. Don’t be shocked when the headlines after the actual data come out to say we are in a recession. Which leads to my next point:
Headline Risk: The stock market is pinballing based on headlines. More Covid-19 than expected? Bad! Sell! Federal Reserve drops rates and pumps money into the system? Good! Buy! Tax cut or other fiscal stimuli? Good! Buy! Saudi Arabia starts an oil price war? Bad! Sell! Covid-19 data is not likely to improve here in the US very soon, at least not for the next 30 days or longer. If that’s the case, I don’t see a sustained recovery in stock prices until headlines are more favorable. Like it or not, headline risk is here to stay, which leads me to my next point:
Traders Without Experience: The last 20% + correction occurred in 2008. A lot of institutional traders today weren’t active then and therefore have never been through anything like this before. Traders with experience have seen it all and are less likely to panic when the going gets tough. Traders with less experience do panic more. Panic doesn’t help.
Lack of Liquidity: After said 2008 correction, during its post-mortem, structural changes were made through Dodd-Frank, the Volcker
Rule, and other laws. The results of these changes were to alter the sources of liquidity away from the traditional banks and toward non-bank financial institutions such as hedge funds. The new liquidity sources don’t have nearly the financial resources as did large Wall Street banks. As often happens when laws change with the best of intentions, the opposite of what was intended actually occurs. The lack of liquidity in the stock market has abetted this sell-off.
Passive vs. Active: For the past several years money has moved out of actively-managed funds and toward passively-managed funds and ETFs. This is a good thing with respect to savings on costs and fees but not a good thing when faced with a sell-off. With fewer actively-managed funds, there is less money out there looking to invest at bargain-basement prices here right after a 25% correction. This is the time for bargain hunters to flock in given the 25% (or more) sale on prices, but those types of shoppers aren’t as plentiful as they used to be.
You might question why Covid-19, as relatively small as it is currently in the US is having such a telescopic effect on the entire economy. Although it sounds like an awful disease, the casualties so far are relatively few and confined mostly to the elderly. The reason is that Covid-19 causes a huge amount of uncertainty throughout the economy. Stocks trade based on a multiple of corporate earnings. Nobody knows the effect that Covid-19 will have on corporate earnings. It will certainly be substantial in the short term but perhaps not as much in the longer term. My advice: Stick to your long-term investing plan. Reallocate among asset classes if you feel the need. Most of all, don’t panic and sell now.