Observations on March Financial Markets

Sam Ngooi Comments

For these Monthly Comments we would like to first note the continuation of the extreme negative impacts of the coronavirus on people’s health and their ability to conduct normal activities. This in turn has created major economic issues, as businesses around the world have had to curtail or shut down their operations, generating high levels of unemployment and creating all sorts of problems for those consumers and businesses dependent on their goods and services. There is little doubt that the impacts of the virus have been a major factor in the current substantial stock price declines in the US and worldwide, as well as a reason for the Federal Reserve to take actions  that have driven US Treasury yields to historic lows, with mixed impact on other bond prices.

From its recent February 19th all-time high of 3,386, the S&P 500 stock index has been as low as 2,237 (March 23rd),  a decline of 1,149 points, or 34%. This means we are currently at the start of the thirteenth bear market (defined as a decline of 20% from a previous high) since the end of World War II. What is different about this bear market is how brief a time it took to reach this level, which in turn brings us to the idea of volatility. Volatility refers to the extent to which prices vary around an average, either up or down, in a given time frame. Consider this:

Starting with the business day of February 20th  (with the S&P 500 at 3,386), and ending March 31st (with the S&P 500 at 2,585), there have been 29 trading days, of which 19 days have been down a total of 2,076  points, averaging approximately 109 points a day, or 3.2% of the February 19th closing value; and 10 days that have been up a total of 1,273 points, an average of about 127 points a day, or 3.8% of the February 19th closing value.  End result: down 801 points, or 23.6% of February 19th closing value. Now what if this same result occurred with an even decline each day of 27.6 points (801 divided by the 29 trading days), or less than one percent a day of the February 19th closing value?  At some point you would have noticed, but the reactions would likely be much more subdued.

The danger of extreme short-term price volatility in the markets is that it gives investors a reason to “do something.” If in fact your long-term goals have not changed, the likely best action is to do nothing, relying on the history of stock price recoveries from bear markets, some even deeper than this one.  Of course, a health pandemic with no clear finish line presents major uncertainties for all. But reacting to the risk by following and acting on the day-to-day extreme ups and downs in the stock market does not seem to us to be that useful.  And remember, your asset allocation away from stocks to bonds, tailored to your particular situation, provides risk reduction, and a source of money as needed so that stocks need not be sold during periods of steep declines.

Or consider that at the March 31st closing level of 2,585, the S&P 500 is actually 78 points, or 3%, higher than the year-end 2018 closing level of 2,507.  So, if you had been traveling in the remotest parts of the world for fifteen months, with no news about stock prices, you would have encountered a very modest gain, but certainly not a bear market. Put another way, while almost all the gains from 2019 (when the S&P 500 index started at 2,507 and closed at 3,231, a gain of 724 points, or almost 29%) are gone, this information does provide a perspective on what is happening currently.

We would also note that as much as these declines can be attributed to the negative impacts of the coronavirus, those same impacts are not likely to be cited as a reason for the up days. We think that stock market moves by traders seeking to profit from short-term price movements are at least partly responsible for all of this volatility. In our February 27th Special Comments, we referenced a New York Times article by Ron Lieber advising people with long term investment goals to try to avoid taking action based on short-term fluctuations. Lieber wrote again on the same subject (NYT, 03/10/20, page B4) as follows: “Current stock market activity, driven in part by out of control algorithms and professional traders with wildly different goals from every day investors like you… Have your long-term goals changed today?  If not, there is probably no reason for your investments to change either… Your actual asset allocation may mean that the declines in your portfolio aren’t as bad as those flashing red numbers.”  (Years ago, we wrote to advocate banning short-term trading because of all the harm it does to long-term investment planning; perhaps this idea should be reviewed again.)

The economic damage done by the “stay at home” policies being implemented to slow the spread of the virus seems certain to result in a recession (defined as two quarters of negative GDP growth). But the question remains whether current stock price levels already reflect this widespread expectation, so that when glimmers of good news appear about slowing the spread, providing reasons to think some relief is in sight, the stock market might be poised to recover. Stock prices reflect investors and traders’ views of the future, both short and long term, which is perhaps a reason for ongoing price volatility, both up and down. Further, how long a recession lasts, and how much economic growth declines during the recession, are always crucial variables.  At this point, it is anyone’s guess what the future holds on these matters.

BONDS:  Bonds are designed to provide a buffer for your investment portfolio, normally generating income and much lower price volatility as compared to stocks. Typically, the older people get, the more their investment portfolio allocation should be tilted towards bonds, even with some stock allocation providing a potential for growth in case they live a very long time. Currently, bond price fluctuations are considerably lower than they are for stock prices. But interest is also very low for bonds, so the tradeoff between price stability and price volatility is particularly stark. Bond prices have come under pressure recently, even as interest rates have declined, because of perceived credit risks with bonds. The Federal Reserve has made it clear, however, that it is ready to support the bond market in a variety of ways (NYT, 4/1/20, page B1). Bonds also provide a source of money for everyone who needs to be using money currently, so that stocks need not be sold in periods of decline. This is a very brief discussion of a complex topic, but we believe the allocations away from stocks and into bonds, established in more normal times based on each client’s particular situation, are doing their job as intended.

To repeat our recent conclusion: We should all be aware that history may not repeat itself, and that the history we know is only one description of events that have happened, as compared to all those other versions that could have happened (see Nick Taleb discussed in January Comments, and Larry Swedroe quoted every month in our Monthly Comments). PPA’s view is that the history we present to support a point of view is at least worthy of consideration. In the absence of better indicators, we repeat our consistent bottom line suggestion: stay the course and think long-term. Please feel free to contact your advisor for additional conversation.