What a week! After more than a month of essentially ignoring news about the spread of the coronavirus, traders finally reacted over the past week with a rush to the exits. We probably don’t have to tell you that stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. have fallen every day this week, nor that prices are now in “correction” territory, down more than 10% from their mid-month record highs.
But the message that may not be front and center if you’re watching the financial news channels is that we’ve seen this many, many times before. The reasons for a sudden sentiment sea change are often different, but the reactions are well-rehearsed; headlines blare, traders sell and long-term investors with well-designed and adaptive portfolios end up profiting the most. As the chart shows, bull marketsA period during which stock prices rise significantly from recent lows for weeks, months or years. last longer and run much higher than the intermittent bears that occasionally intrude—we’re nowhere near a bear marketA period in which stock prices decline significantly from recent highs and remain below previous high marks for weeks or months. Generally, a decline of at least 20% in stock prices is considered the threshold marking the start of a bear market. at the moment.
Through Friday, the Dow Jones Industrial Average and the broader S&P 500 index were down 10.6% and 8.3% on the year, respectively. The MSCI EAFE index, a measure of developed international stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. markets, is down 10.6%. As of Thursday, the yieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. on the Bloomberg Barclays U.S. Aggregate BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. index has declined to 1.84% from 2.02% last week, and from 2.31% at 2019’s end. On a total return basis, the U.S. bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. market has gained 3.0% for the year. (Friday’s numbers were unavailable as we went to press.)
If we look at those times when stocks fell this hard, those periods tended to herald buying opportunities.
Market Dive Is Not a Swan Song
Only a week ago, we were discussing stocks’ record highs and wondering if perhaps traders were being too blasé about the likely impact of the coronavirus.
An under-reaction is not how anyone would describe this week’s market performance. As of Friday night, the S&P 500 index has declined in each of the last seven trading days—including declines of 3.4%, 3.0% and 4.2% on Monday, Tuesday and Thursday, respectively—for a total drop of 12.8%.
Such a sharp, swift decline is never pleasant, but as long-term investors, our focus is far different than those trying to play the day-to-day market histrionics—allowing us to put the recent seven-day drop into perspective.
That 12.8% seven-day decline ranks as the S&P 500’s 18th-worst seven-day run since its March 1957 inception. So, this ranks among the most trying weeks for investors and traders. But we’ve been through worse.
More to the point, if we look at those times when stocks fell this hard, those periods tended to herald buying opportunities.
Since its inception, the S&P 500 index has averaged an 8.3% gain over all 12-month rolling periods. But, after the 17 times the S&P fell more than 12.8% in seven days, the average 12-month return was 18.8%. That’s what you call a nice rebound. And even better, the index was higher in 16 out of 17 cases.
One final stat for you—one you may have heard from us before: In any given calendar year, the S&P 500 index averages a decline of about 13% to 14%. So, the current decline is roughly on par with what we should expect entering any given year (granted it has run faster than the average decline). Still, remember that despite averaging intra-year declines of 13% to 14%, the S&P 500 index has compounded at nearly 11% a year over the last 36 years or so. StockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market declines, pullbacks, corrections and even bear marketsA period in which stock prices decline significantly from recent highs and remain below previous high marks for weeks or months. Generally, a decline of at least 20% in stock prices is considered the threshold marking the start of a bear market. are a fact of life for investors, yet the long-term record clearly favors those who maintain exposure to stocks as opposed to trying to flit in and out, or “time” the market.
Recession Improbable, Not Impossible for U.S.
While this week’s focus was on the human contagion associated with the coronavirus, stocks were falling in part due to worries about the economic consequences of a business contagion: Lower consumer demand coupled with disrupted supply chains, primarily linked to China.
Could the impact of the virus be enough to trigger a recession? Our verdict is that while a recession in Europe is probable and a global recession is possible, it’s unlikely we’ll see one in the U.S.
Why do we believe a recession here is unlikely? All the pre-outbreak data—from economic growth running at 2.1% in the final three months of 2019 to elevated consumer confidence and increasing home sales and durable goods orders—tells us that the U.S. economy was firmly on a slow-growth track before the outbreak worsened. The U.S. economy, driven by its large consumer base, tends to be more resilient to problems outside its borders.
That’s not to say that the impact of the virus will not be felt here or abroad. The coronavirus could take a toll on company earnings this quarter, and possibly the next one, but as it runs its course and normal activity resumes, it’s likely that economic activity will rebound even more strongly in the latter half of the year. Velocity to the downside based on coronavirus fears may well yield a similar kind of velocity to the upside.
We would caution, however, that economic and earnings data will likely be particularly noisy in the coming quarter and that the shoot-first-and-ask-questions-later mentality on Wall Street could lead to further increased volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in., at least over the next few months.
We are witnessing what, to coin a phrase, we will call a “growth-projection correction”— a market correction on conjecture about estimates for economic activity and earnings growth based on the coronavirus’ potential global toll on the pace and rate of manufacturing, productivity, shipment, supply and consumption.
The good news: To us and the strategies we run, this growth-projection correction is based on (a) contraction conjecture and (b) an exogenous event relative to fundamentals—earnings, interest rates, economic data—that, in the main, are still in expansion mode. This, along with the historical data presented above, suggests that a rebound of similar magnitude (to whatever the ultimate maximum cumulative loss turns out to be) is in store.
So, while we can’t promise that a measure of calm will return to the stock markets or the news media over the next few weeks, we can promise to stick to our models’ signals and not let emotions drive investment decisions.
As always, please feel free to contact us if you’d like to discuss further. Our strategists are in constant conversation with one another and are always available to answer questions or expand on any topics discussed here.
Financial Planning Focus
Financial-Aid Deadlines Approach
Shifting gears from coronavirus fears, one of the best long-term investments you can make is in higher education. If you’ve got a prospective college student in your household, you’ve either heard, or know first-hand, how daunting the process of finding and applying for financial aid can be.
One crucial step that all prospective students should take is filling out a Free Application for Federal Student Aid (FAFSA) form.
A FAFSA qualifies students for financial aid from Uncle Sam. And though the FAFSA is a federal form, most state governments and colleges use it to calculate how much financial aid to award prospective students as well. Completing this one form will give you a much better picture of the kinds of grants, loans and work-study programs that may be open to your higher-ed-bound child.
Naturally, there’s always a rub: You need to be aware of three important deadlines related to college, state and federal aid. Deadlines vary among institutions and they may be approaching sooner than you think.
For students enrolling in fall 2020, you’ll likely need to send a FAFSA…
… to your college by spring 2020. Most colleges require financial aid applications to be made well in advance of the next academic year, often by March for September enrollment. To find the deadline for your school, call the financial aid office or check the school’s website.
… to your state aid office by spring/summer 2020. “State” here means the state you live in rather than the one where the school is located. You can find the deadline for your home state on the front page of the FAFSA website.
… to the federal government by June 30, 2021. This is standard for everyone, and it’s the latest of the three. (If you’re planning to begin classes in the spring or summer of this year, you can apply for federal aid as late as June 30, 2020.)
Our advice is to use the earliest of the three deadlines as your cutoff for completion. Many colleges and states offer aid on a first-come, first-served basis. The window to file the FAFSA always opens on October 1, and we’ve found that best practice is to file your form as soon as you can after that for every year you anticipate having a student in college. Remember, you need to apply for financial aid every year, not just in the year prior to entering college.
If you have any questions about the FAFSA form and how to fill it out, please contact your wealth management team. We’re happy to help.
Next week will bring us manufacturing and service sector gauges, construction spending and car sales, factory orders, ADP and nonfarm payrolls job reports, hourly earnings and consumer credit and the Federal Reserve’s Beige Book of anecdotal economic reports from around the country.
As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.
Please note: This update was prepared on Friday, February 28, 2020, after the market’s close.
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