The significant spread of the coronavirus around the globe is increasing the risks of a meaningful global economic slowdown, which could push the US into a recession later this year or early 2021. Forecasting the economic impact of a previously unknown virus is nearly impossible. Add to that the recent oil price shock caused by a breakdown between OPEC and Russia and the market is trying to assess a dual threat to growth.
The Million Dollar question is will any recession be short and shallow or long and deep. Given that the US economy was on pretty solid footing before the onset of the coronavirus, I expect it to be in the short and shallow variety. One concern I have is the slow response we are getting from governments around the world in terms of fiscal and monetary policy. As these policies generally have a lagging effect, the longer it is before they are implemented, the greater the risk any recession becomes more painful.
March 9, 2009 marked the bottom of the last bear market and the start of an 11 year bull market. I believe the stock market likely remains in a long-term bull market but we are likely looking at a cyclical bear market right now. A piece of positive news for stocks is that cyclical bears within secular bulls tend to be less severe, and also tend to be shorter. The general definition of a bear market is a 20% decline from the previous high water mark on the S&P 500. As I am writing this (10:47am EST) the S&P 500 is down just under 18%. During the current bull market we have already experienced 2 cyclical bear markets (April through October 2011 and September through December 2018).
Where is the bottom for the markets? Bottoms can only be seen in hindsight, but generally there is a ‘bottoming process’ that can give us some insight. They tend to follow a pattern of 1) hitting oversold levels; 2) rebounding; 3) retesting; and 4) triggering a washout in investor sentiment. This process can take anywhere from a couple of weeks to several months. So far we have completed steps 1, 2 and 3 a couple of times over the last two weeks. However, we haven’t seen the real washout in sentiment I want to see before feeling comfortable.
I expect to see steps 1 through 3 repeating over and over again for the near future. I could be wrong. but I think we are likely to retest the lows from the last bear market, which was 2,350 on the S&P 500 from December 2018. That’s roughly 15% below where we are today. As such, we continue to de-risk portfolios on the rebounds. For those of you with investment accounts not under our management and/or employer retirement plans (401k, 403b) I suggest you consider lowering your equity exposure on any rebounds. You should consider taking 20-25% out of the equity funds in your account and putting that in the cash option – on the next rebound. As you can see from the chart above, this will require you to pay attention on a daily basis. Don’t adjust your future contributions – just lower the current balance in equities. As always, consider your investment objectives, risk tolerance and time horizon in making any changes.
Assuming the coronavirus does not have a lasting impact on the economy, the coming monetary and fiscal stimulus, combined with a deeply oversold market and extreme pessimism, should ultimately help set the stage for a powerful rally like we saw in 2019. We will let you know when we think it’s time to get back into the market.
Remember that your financial plan was constructed to deal with market volatility and the inevitable pullbacks. Feel free to call me with any questions or concerns.
Sources: Ned Davis Research, Bloomberg
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