What Has Happened So Far?
On February 19th, the S&P 500® peaked at a value of 3,386. Since then, it has fallen precipitously, reaching 2,480 at yesterday’s close, a decline of about 27%. For the year to date, the US large cap market, as measured by the S&P 500®, has dropped about 23%. Small cap and European stocks have fallen more, while stocks in Asia have declined less. The swiftness and severity of these declines is reminiscent of prior big market shocks like 2008, 2000 and 1987.
Why Has This Happened?
We believe there are two primary causes.
First and most obvious is the potential impact on the economy due to COVID-19 virus mitigation. As this novel virus hit both US coasts and then spread relatively quickly across the country, we have seen wave after wave of cancellations and closures. Governments and private businesses have moved to limit large gatherings. A new term has been coined -- social distancing – to describe the behavior each of us should practice in order to prevent the further spread of the virus. As testing ramps up, we should expect to see the number of reported cases continue to rise sharply for several weeks.
The secondary cause is a dramatic drop in the price of oil which was precipitated by the failure of OPEC and Russia to reach an agreement on production cuts in response to lower demand, primarily from China as it dealt with COVID-19. Instead, the Saudis and the Russians launched a price war, driving oil prices sharply lower. This immediately led to concerns about the ability of energy companies to service their debt.
Where Do We Go From Here?
The negative impact on the US economy in the short term will continue to grow as more cancellations and closures take place Fortunately, prior to this outbreak, the US economy was in good shape. But there is no doubt that the economy will take a very significant hit as a great deal of economic activity comes to a sudden stop. The most important financial question is: how long will these restraints stay on the economy? Or said another way, when we will get past the peak virus spread? No one knows how this will play out in the US but lessons from China are at least directionally instructive. With strict limits on activity in the “hot zone,” China’s new cases are now negligible, about 3 months after the infection became known.
As we ramp up testing and quarantining, we will certainly see the number of reported cases jump very dramatically in the coming weeks. At the same time, we believe that the effects of closures and cancellations, personal hygiene improvements and social distancing will begin to have an impact on the spread.
Finally, the pharmaceutical industry is working furiously on treatments (for short term assistance to the sick) and vaccinations (a long term prevention mechanism). But this is a difficult problem so we need to temper our expectations for quick progress. While we can now cure or effectively treat killer viruses such as hepatitis C and HIV, we don’t have an effective cure for the seasonal flu.
What Are You Doing in Portfolios?
In the early stages of the downturn, we added modestly to stocks, expecting that this would be the type of correction we typically see once or twice a year: a 5-15% pullback. As it became clear over the course of this week that the damage to the markets and the economy would be deeper, we have become very selective in making additions to client portfolios.
We are closely monitoring developments in the fixed income markets. We have seen some dramatic and unusual movements that are indicative of liquidity pressures, as investors have scrambled to raise cash. As prices on closed end funds have reached highly distressed levels, we have started to add these to client portfolios for which they are suited.
Finally, we have also started to realize tax losses on certain positions and are generally reinvesting the proceeds as we do not know when the market will turn around. History teaches us that it will but the timing is uncertain. We continue to be diligent in monitoring the markets and client portfolios, looking to take advantage of short term dislocations for long term benefits.