The Tug-of-War Between the Bulls and the Bears Continues

Editor's Note: The following section was written on April 30.

After one of the sharpest drops into a bear market (indicated by a decline of 20% in major market indexes) due to economic fears around the COVID-19 containment measures, April saw one of the strongest months on record for stocks in the last 45 years. The tension between truly terrible economic data—over 12% of the U.S. workforce is now covered by unemployment benefits, the economy shrunk in the first quarter at an annual rate of almost 5%, with worse results to come in the second quarter, and corporate earnings are extremely strained—and the strength of equity markets have left investors puzzled.

It Might Be Hard to See, But What’s Happening in the Markets Has a Rational Basis

The headlines around the market’s strength don’t tell the full story, however. Despite appearances, the market is being somewhat rational because sectors, like health care, have been hurt the least, while sectors like energy, which has been hammed by declines in demand, have declined the most. What is more interesting is that the winners have won big. Five mega cap tech names now make up 20% of the S&P 500 index—we haven’t seen concentration like that in more than 60 years.

The success of these companies’ business models is what is powering the S&P 500’s recovery while leaving international, value and Small-Cap stocks lagging. While these laggards caught up a bit last week, they have a long way to go to catch the performance of the mega-cap tech companies. That doesn’t mean it won’t eventually happen. Over time, Small-Cap and Value companies have outperformed Large-Cap and Growth, specifically because these types of companies are riskier and investors demand a higher premium to hold them.

International and U.S. stocks have traded leadership positions over time; while U.S. stocks have dominated since the great financial crisis of 2008-2009, that’s not necessarily what will happen in the future. Since no one can reliably predict which sector, geography, or factor will have the highest performance at a given time, diversification is still the wise approach.

So, while the market has had recent winners and losers, the question of how there can be winners at all still puzzles some investors, given current events. The answer is that investors seem to be looking through the next six to nine months, toward more normalized earnings, thereby discounting the short term decline in corporate earnings and cash flow. The basis for this appears to rest on the idea that the economy will re-open, and life will get back to normal.

Three Reasons for Optimism

Despite the dominance of negative headlines, there are several good reasons for this line of thinking. First, we have made major progress against the virus. Containment has worked to flatten the curve, which has kept the hospital system from becoming overwhelmed. Deaths have been declining in COVID-19 hot zones (like Italy and New York). Research related to potential treatments and a vaccine is progressing.

Second, the Federal government is filling the hole left by the slowdown in consumer and business investment with massive stimulus packages. So while the economy is contracting at an unprecedented rate, the government is back-filling the loss of activity with loan programs, grants and unemployment. While this might not be enough to keep the economy from cratering, it will help keep many businesses and households solvent so that when the economy rebounds, they can get back to business.

Finally, the world is starting to reopen. China appears to have resumed economic activity without sparking a major uptick in infection rates, as has South Korea, which never imposed a full shutdown. U.S. states are starting to reopen; Georgia has reopened all shops and restaurants; Texas is allowing businesses to reopen at 25% capacity, and Minnesota is allowing manufacturing to resume. The world, America included, is getting back to business.

So while there are some reasons to be optimistic against the backdrop of gloomy economic data, the volatility of the last 8 weeks is very likely to continue as investor sentiment about the market swings between the bear case and the bull case. Understanding your risk tolerance and liquidity needs is the surest way to make the right decisions during levels of high volatility. Never try to time the market, it just doesn’t work.  If you own stocks, own them for the long term, which means having other sources of liquidity in your portfolio, so you don’t have to sell when markets are depressed.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Bulls vs. Bears: The Fight Behind Ongoing Market Volatility

Editor's Note: The following section was written on April 22.

As earning season continues, the impact the COVID-19 containment efforts are having on the economy is coming more into focus, and the view is less than stellar. And yet, the market is holding well above its lows from March 23. One thing that’s different about this sell-off compared to others is the polarization I hear between market optimists (bulls) and pessimists (bears).

This extreme polarization is the source of the volatility we are seeing in the markets, but the truth rarely lies at the extremes. However, understanding both sides can help build a well-rounded view of the market situation. As such, I thought it was worthwhile to layout both the bull and the bear arguments, as I understand them.

The Bull Argument

The bull case starts with the assumption that the containment efforts around COVID-19 will start to soften sooner rather than later and economic activity will begin to rebound. While most bulls acknowledge the recovery is going to take a while (e.g., the hopes of a V-type bounce is largely out of the question), earnings will eventually bounce back—no matter how bad the data is over the next six months.

Further, once the recovery gets going, it’s going to be supercharged by low interest rates and government spending—not to mention deferred demand from consumers- and businesses-from the last few months. So, the bulls look beyond the next six months, and believe the world is likely to be back to normal (or better) in a year or so.

The Bear Argument

The bear case starts with doubts that the containment measures will soften, noting that even if they do, infections will just spike again and put us back in the same situation we found ourselves in early March. Bears are also more pessimistic about finding a vaccine; it could be a decade as opposed to 12–18 months. And even after the economy reopens, consumers are likely to save more and spend less (e.g., Depression Era syndrome), and businesses will think twice before making capital expenditures and hiring, resulting in falling demand.

While bulls see low interest rates far into the future, bears see all the government debt that’s piling up and must be repaid. There are three ways to repay government debt: higher taxes, higher growth or higher inflation. Given that higher growth is hard (if not impossible) to achieve, we are looking at higher taxes (bad for stocks) or higher inflation, which will cause interest rates to go up and provide a headwind for equity prices. Oh, and then there are the rumors surrounding North Korea’s reclusive dictator who may or may not be dead. A transition of power in North Korea might not be good for markets, as a new leader is likely to rattle the saber a bit—maybe test some nukes or fire some midrange missiles.

The Verdict

A good friend and great investor once told me, bears have better facts, but bulls make more money. I think there is a lot of truth in that. The bull story seems a bit too optimistic, and the bear story seems to correspond with the data a bit better. That said, being long on stocks for the long term is generally the right decision, and trying to time the market isn’t. So, whether you’re a bear or a bull (or hopefully, you’re neither), a long-term approach to investing may be the soundest decision.

For more information on market changes due to COVID-19, check out our COVID-19 Resource Center for the latest news and updates.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

How to Reconcile Bad News With Good Market Returns

Editor's Note: The following section was written on April 15.

It’s a confusing time for investors. The headlines tell a very negative story. So far, first-quarter earnings have been disheartening, unemployment claims are increasing, and pundits are predicting that the second quarter will bring the deepest recession since the Great Depression. While COVID-19 deaths may be peaking, the coronavirus will be an ongoing concern, complicating restarting the economy. And yet, the market has made up about two-thirds of its losses.

The rally is ostensibly on the back of improvements in infection rates and suggestions that the economy will start opening relatively soon (meaning weeks instead of months). But one thing we know about viral outbreaks is that they are fairly predictable. Even in early March, epidemiological models predicted that COVID-19 would peak in April.

While we have greater clarity now, we had reasonably accurate models during the peak of the sell-off; the most reasonable (and well-capitalized) market participants probably just shrugged off the potential short-term impact of COVID-19 containment efforts, believing that equity markets tend to reward investors over the long term. Despite this, the markets moved. Why?

Understanding Market Valuation

One way to understand market valuation is the Dividend Discount Model (DDM). The DDM tells us that the price of the market should be equal to:

  • Total dividends and share buybacks (e.g., the net cash that investors can expect to receive),
  • Divided by the risk-free rate (e.g., the 10-year treasury rate) plus the risk premium (e.g., how much more investors require in return to hold stocks over 10-year treasuries), less the long-term growth rate in earnings.

dividend discount model

Which Factor Is Driving Market Performance?

Once you understand this model, you can begin to see that news that impacts any of these factors can also impact the markets. The question is, which of these factors is moving the market now? We can probably rule out growth and dividends and buybacks.

Dividends and buybacks are closely related to earnings. When earnings are down, the market tends to look through bad quarters to come up with a more “normalized” value, so while the next six months could be ugly, the market is thinking in normalized terms, which probably haven’t changed much, even with the introduction of COVID-19. It turns out that real earnings growth (after inflation) is relatively constant over time at about 3%, which is about the same as GDP growth (see Figure 2).

LT earnings growth

COVID-19 is unlikely to slow real earnings growth over the long run, even if it hurts 2020 results. With a vaccine 12 to 18 months out, the world will certainly face new challenges, but we don’t expect COVID-19 to alter the trajectory of the last 100 years. So, the growth factor probably isn’t behind the recent market movement. That leaves the risk-free rate and the required risk premium for our current market movers.

The risk-free rate—the 10-year treasury—has dropped considerably as inflation expectations have declined and the Fed has engaged in additional quantitative easing measures. Lower risk-free rates are supportive of equity prices; therefore, the longer rates are low, the more attractive equities look relative to bonds.

Now, the big market-mover: equity risk premium, defined as how much incremental return investors require from an equity investment in exchange for the additional risk taken on versus a safer asset. It turns out that equity risk premium is the most volatile factor in the valuation equation. With COVID-19, investors are demanding a higher premium for holding stock than safe bonds. We can’t say exactly why (especially if you believe that stocks will be higher in the future), but we can certainly see it in the data in Figure 3 below. The takeaway from this is that high-risk premiums generally correlate with strong returns over three to five years.

earnings growth 2

What’s the Bottom Line?

When the market is ignoring the fact that equities are almost always higher in the long run because of relatively consistent growth, you should take the opportunity to buy if it makes sense within your financial plan. One final note, while risk premium is predictive of returns over the longer term, it's not predictive of short-term returns; they could be terrible, or they could be great. If you decide to buy equities when the risk premium is high, you need to make sure that you have enough liquidity to meet your needs so you won’t be forced to sell equities if the short-term returns turn out to be terrible.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Market Rally Continues Despite Terrible Headlines

Editor's Note: The following section was written on April 8.

We express our sympathy to the family, friends and loved ones impacted by COVID-19 as deaths begin to peak in the U.S. New York announced its highest daily death count on April 8, reporting that 779 people had died. Despite this horrific news, investors found a reason for optimism: Hope that infections might be peaking and may begin to decline—meaning the economy can start to reopen and we can all get back to normal—and the market rally off its recent low continued. In the chart below you can see the reported deaths in New York (orange line) to the Institute for Health Metrics and Evaluation (IMHE) model of infections put out by the University of Washington. The IHME model (or one very similar) will likely be used by policy makers when determining when to re-open the economy. The slight dip in the reported deaths below the mean estimate sparked the rally Monday that continued into Wednesday.

NY Deaths Per Day vs. IHME Model

Source: IHME,, WEAS

And while the data trends are certainly good news, talk will turn to the possible resurgence of the virus once we are past the peak. Every time a few cases are identified, concern will spike that we might have the beginning of the next exponential pocket, questions about renewed social distancing will abound, and fear will roil the markets. This is the pattern that characterized the Spanish Flu of 1918, where the initial spike was followed up by a lesser, but still deadly, outbreak a few months later.

It’s Not All Downhill From Here

With evidence of the curve flattening and the recent market rally, it is tempting to think that both the economic and pandemic crises have passed; however, we think such optimism is foolhardy. Fortunately, it now appears that fewer people will die from the virus than previously estimated due to effective countermeasures like social distancing; however, the economic impact is just hitting the world, and recovery will not be “V” shaped. A recent Bloomberg survey shows that, on average, economists estimate U.S. GDP will contract by about 30% in Q2 2020, on an annualized basis, and may not return to February 2020 growth rates until after 2021. Goldman Sachs predicts that 2020 earnings for the S&P 500 will decline 30% or more. As we look ahead, the economic data isn’t pretty: government deficits running into the trillions combined with Federal bond-buying that will add trillions more will create economic headwinds for years to come. Behavioral changes implemented to contain the virus will hinder economic recovery by limiting travel, entertainment spending, and a host of other normal consumption patterns businesses rely on until a vaccine becomes widely available.

It’s a confusing moment for market participants:

  • The virus is peaking, but will it return?
  • The market is rallying, but will real economic activity support it?

We don’t know the answer to these questions, and neither do other market participants. As such, the market is likely to lurch between optimism and pessimism on what will often be statistically insignificant data points—the result will be continued volatility. We don’t know what direction the market will move in the near term, no one does, but our data suggests that the market will continue to move up and down a lot. In a market like this one, which we expect will continue, the best approach is usually to stay the course. Significant positive market days tend to cluster around significant negative days, so being out of the market means you’re likely to miss those positive days, which may be detrimental to your returns for decades to come.

Headlines Get Worse Before They Get Better

Editor's Note: The following section was written on April 3.

Market volatility continued this week, as the U.S. likely approaches peak infection and death rates resulting from COVID-19 and the economic impact of the efforts to contain the virus began transforming from projections to realities.

Starting with the virus itself; infections topped 1 million globally, while deaths in the U.S. rose to over 6,000; epidemiological models project deaths to peak on the east coast in mid-April and for the central U.S. in late April, so expect headlines to get worse before they start getting better. On the economic front, 6.6 million individuals in the U.S. filed for unemployment this week. That’s nearly 10x more than the highest weekly job loss the economy has ever seen, barring last week. We expect more job losses in the weeks to come, as nearly every economic indicator and corporate profits turn the brightest shades of red. Be ready for the headlines over the next few weeks as they will test the resolve of even the most seasoned investor.

Even though the news will be difficult, it doesn’t mean the markets will decline. While volatility tends to beget volatility, it doesn’t tell investors anything about the direction of the market. It's impossible to say whether it takes collective market participants 2 days, 2 months, or 2 years to see through the turmoil of the next few weeks. What we do know is that markets tend to reward investors over the long-term, and unless you are in a position such that you are forced to sell stocks—which you shouldn’t be if you have a solid financial plan—holding through volatility has historically been a much more successful strategy than attempting to time the up and downs.

Fortunately, there are things you can do. As markets gyrate, there are opportunities to tax loss harvest portfolios to offset gains for future years, buy quality companies at discounts and take advantage of potential miss pricings in the bond markets. Our investment team is working to turn the current volatility to our clients long-term advantage, and while it may not show immediately, our portfolios will be better positioned for the long term because of the decisions we have made and will make over the next few weeks.

In the Eye of the Storm

Editor's Note: The following section was written on April 1.

Yesterday brought the end to the first quarter of 2020. January seems so far away as the COVID-19 virus impacted every aspect of our lives, reduced our freedom of movement, and created anxiety around both our portfolios and the health of ourselves and loved ones. As the situation has emerged, it’s been important for our clients to know that we are fully functional and continue to be here for them to offer advice during this difficult time.

The current crisis is different than past crises in that this is a distinctly human one—models suggest that over 100,000 Americans may die of the virus in the coming months. That said, it is different than other crises because, unlike the 2008–2009 Financial crisis, no one knew when it would end. The current situation will hopefully abate by late summer through social distancing and other measures and come to conclusion 12 to 18 months from now with a wide-spread vaccine. The question then will be how fast the economy comes back online—and we believe that government stimulus packages, ultra-low interest rates and deferred demand will help accelerate the recovery, but it may take longer than many expect.

Things Will Get Worse Before They Get Better

While the markets have rallied off their lows, no one knows what markets will do in the short term—we are now in the “eye of the storm.” The crisis that was predicted is starting to come to fruition. On the human side, cases are spiking and models suggest that as the virus peaks in mid-April, more than 2,000 Americans could be dying each day from COVID-19. We all knew that shutting down the economy would have consequences, and last week we got our first look at the data, including over 3 million lost jobs.

That is likely only the beginning. Analysts think that the fall of economic activity will be the worst since the end of World War II. In the coming days, corporations will report tanking profits, more jobs will be lost, businesses will close, and families will declare bankruptcy. Even with the $2 trillion government relief package, and likely more on the way, impacts will be felt.

Five years from now, we will certainly be surprised if equity markets are not substantially higher than they are today—how we get there is unknown The headlines over the next few weeks may test even the most stoic investor’s resolve to stay the course, but crisis after crisis has demonstrated that staying the course and not giving in to the desire to sell will yield the best long-term returns.

Understanding "Volatility"

The anticipation of what is coming has elevated volatility to levels not seen since the great recession. Most readers know that volatility is a measure of risk, and while there are many different measures of volatility, historical volatility is measured by the standard deviation of returns of a given asset. If we take the S&P 500, for instance, the average daily price move (either up or down) since February of 1927 is 0.075%. Between the March 1 and March 30, the average daily price move (either up or down) was 5.06%—that’s more than 670x the normal daily average move. The graph below will help you visualize.

Source: Bloomberg/WEAS

Volatility was low at the beginning of the year, and you can sense this intuitively by looking at the daily returns up to late February. As the uncertainty of the virus started to take hold, volatility soared. There are lessons to take from this visualization of volatility:

  • Volatility moves in regimes. When volatility is low, it tends to stay low, and when it’s high, it tends to stay high (at least for some period of time).
  • Don’t try to predict returns day-to-day. There isn’t a pattern in the direction. It’s as close to random as you can get, so don’t try to time the market.

The headlines are about to get worse, and the high levels of volatility are here to stay, for at least a while, so pains of the first quarter are likely to spill over into the second quarter. Those that stay the course are likely to come out the other side with their financial and life plans intact. Stay safe.

Managing Portfolios During Market Volatility 

Editor's Note: The following section was written on March 27.

The past week has been full of unprecedented events impacting every aspect of our lives, families, governments, society, wallets, and especially, our daily routines. Infection rates in Europe and the United States are spiking (along with mortalities) and one-third of the earth’s population is under some form of lockdown or shelter in place. The federal government is on the brink of passing the largest relief spending bill in history ($2 Trillion) to keep business and families from going bankrupt in the short term and the Federal Reserve has committed to buy unlimited amounts of bonds. So far millions of people have lost their jobs with millions more at risk and global markets have produced large losses for investors. While these headlines are certainly depressing, even worse headlines are likely to come before we get through the worst of the COVID-19 crisis which, from an infection perspective, might be 30 days away.

Despite these headlines of doom and gloom, it was generally a very good week for stocks and bonds.  Combined, this serves as a powerful reminder not to try to time the market, especially one this volatile. The worst may not be over for equity markets, we may retest the lows, or we may not. No one knows the short-term path of markets (if anyone tells you they do, don’t trust them!), which is why a solid financial plan that ensures you aren’t forced to sell equities during a downturn is the best approach for most investors. That said, we have not sat idle, over the last week we have been actively positioning the portfolios to take advantage of recent events. Over the last two weeks, when appropriate, we have been engaged in:

Portfolio Rebalancing

Portfolio Rebalancing is the practice of selling portfolio assets that went up to buy assets that went down to return your portfolio to a target allocation, this is often done automatically when your portfolio reaches a pre-determined threshold. When markets are highly volatile, we wait to rebalance portfolios so that we don’t buy more stocks in a continually falling market. Last week we determined that it made sense to re-balance, so we started selling some bonds and buying stocks across portfolios. The benefit is that by buying stocks low while getting you back your target allocation positions you maximize your return when the market rebounds without taking on more risk.

Investing in Real Estate

We added real estate to most portfolios in the form of an Exchange-Traded Fund (ETF) that buys Real Estate Investment Trusts (REITs) because we believe real estate adds protection, yield and increased return opportunity to the portfolio. We believe long term-leases provide some protection if the crisis continues because the yield is very attractive in the current ultra-low interest rate environment and, after the stimulus package, we expect real estate prices to go up as inflation expectations rise.

Tax Loss Harvesting

In addition to buying equities at low prices, as mentioned above, market declines also create an opportunity to harvest your losses for a tax gain. Tax Loss Harvesting is a tax-efficient tactic where we sell one investment at a loss and replace it with another very similar investment. We can take the loss and use it to offset future gains, reducing future tax bills.

Re-positioning Equity Holdings

While you may not see 1000s of trades occurring in your account, they are happening inside of the ETF and Mutual Funds that you hold. For example, the momentum strategy funds have been actively selling losers directly impacted by the virus and replacing those companies with higher-quality names that are likely to hold up better as volatility persists. Similarly, the value funds have been buying high-quality companies, with characteristics of good business models that are cheaper due to the recent sell-off with the hope of enhancing future returns.

These are difficult and strange times for everyone. Fortunately, at Wealth Enhancement Group, we have the right technology, people and processes in place so that despite our offices being closed, your team and I can continue to provide the same planning, guidance, and advice that we always have. If you have additional questions please reach out to myself or the team.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

Markets Respond to CARES Act

Editor's Note: The following section was written on March 25 at 7:00 p.m.

On the back of Tuesday's record-breaking rally, it was the Dow Jones Industrial Average's best day since 1933; the markets moved higher again today. The rally was most likely fueled by reports that a $2 trillion “emergency relief” bill is moving through the senate after Democrats and Republicans reached an agreement late Tuesday. Senate Majority Leader Mitch McConnell discussed the bill, named the Coronavirus Aid, Relief and Economic Security Act (CARES) on the senate floor today – he characterized the spending measures as both economic stimulus and economic relief. 

The CARES Act as Stimulus

Generally, stimulus bills are passed when the economy needs a jolt. We saw this with the structural imbalance in the economy during the 2008-2009 financial crisis when Congress passed measures to bail out banks, and following the normal, cyclical slowdown during the recession of the early ’90s. Currently, the economy only needs a "jolt" because measures put in place to address the spread of the virus, including widespread closures, essentially “de-stimulated” the economy. 

The CARES Act as Relief

If the CARES Act provides economic stimulus because it gives the ecnomy a needed "jolt," it is also a relief to the extent that it provides a stop-gap measure for the economic pain to come. This relief is about keeping good individuals, families and companies liquid (e.g., they have enough cash to pay their bills) so they can remain solvent (e.g. not bankrupt) during the next several months and emerge on the other side of this pandemic ready to actively participate in the broader economy.  

Late in the trading day, however, word started to leak from the Senate that the agreement reached in the wee hours of Tuesday night, might not hold amidst renewed partisan bickering. As a result, the market gave back some of its impressive gains, but most indexes finished in positive territory.

COVID-19 Pandemic Update

Yesterday's headlines regarding the coronavirus continued to be dark. Reports included more deaths in Italy, exponentially rising infection rates in New York and new cases confirmed in Tokyo. If you read beyond the headlines, however, new infections in Italy are peaking and starting to decline; New York is preparing for peak infections about 14 days from now by adding hospital beds, medical staff, and supplies. With all the negative headlines, it can be hard to figure out how this ends, but as we discussed on today's webinar, the situation in South Korea shows that with social distancing, testing and a high level of vigilance, we'll see new cases decline, recoveries will start to outpace new infections, and life will start to get back to normal.

Markets React to Positive News

Editor's Note: The following section was posted March 24, 2020 at 8:30 p.m.

We know that periods of high volatility aren’t limited to market declines, but rather, where the market moves in big ways and where the direction is impossible to predict from day-to-day. Despite that knowledge, it still feels good when the market has a day like yesterday, with the MSCI All World Composite up about 8% and major U.S. market indexes up even more. It seems that several positive news stories combined to help drive the markets higher.

Federal Reserve Takes Action to Increase Liquidity

The Federal Reserve committed to buy an unlimited amount of treasuries, mortgages and high-grade corporate bonds, including exchange-traded funds, increased market confidence and boosted both stock and bond markets. The goal is ensuring that the current crisis of liquidity for business and individuals doesn’t turn into a crisis of solvency; we don’t want cash shortages to bankrupt otherwise solid businesses and families. The Fed is helping to stave off a worse crisis by ensuring that credit flows to those that need it. 

Congress Continues to Negotiate Terms of Economic Stimulus Package

While the Fed moves on liquidity, Congress looks set to pass an ever-expanding economic stimulus package. The proposal, which started as a $700 billion series of loan guarantees and direct payments to individuals has ballooned into a $2.5 Trillion package with something for everyone. It might appear irresponsible to spend so much when the U.S. already has a large deficit however, the long term costs will be higher if we fail to act. For instance, the cost to help a business keep an individual employed is much lower than if that employee gets laid off and goes on government assistance until they find new employment, which may not be until the economy recovers. My hunch is that while we need to do everything we can today to keep the economy running, we’ll also continue to discuss the debt incurred to do so for the foreseeable future.

Implementing "Test and Trace" Could Help Avoid A Prolonged Lockdown

Today, the President told a group of hedge fund executives (and then the rest of us) that he wants to “open” the economy by mid-April. While mid-April might be a bit unrealistic, we do think the general sentiment is turning towards opening up faster as opposed to a prolonged lockdown. If we can contain the virus, then we can start to open areas of the country with lower rates of infection. We can limit flare-ups by implementing “test and trace” protocols; test anyone who might be sick and if positive, find everyone they were in contact with and quarantine those individuals well as high-risk individuals. If successful this approach could buy us a year or more, which gets us to the point where a widespread vaccine could bring an end to this horrible event. This situation presents tough ethical decisions that neither economists nor epidemiologists are well-equipped to answer but that, as a society, we need to make, and live with, for years to come.

One more thought from today on the virus; infections in the U.S. and the New York Metro area, specifically, are spiking. There are currently more than 50,000 confirmed cases in the U.S.—up from 66 on March 1—and almost a third are in the New York Metro area. No doubt, spikes in infection rates are scary, but they're also a positive sign that testing is also increasing. In early March the U.S. was only conducting a few hundred COVID-19 tests a day; this week we conducted about 65,000 tests a day and the number will go up as the test becomes more widely available. So while epidemiologists predict an exponential increase in infections, that increase is also the beginning of containing the virus; the more we test, the more we can quarantine and treat. In China and S. Korea, aggressive testing was instrumental in helping to reduce infections so they could get on with life. Both countries experienced the same rapid spike in infections as seen in New York, followed by lockdowns and testing and eventually more people recovered each day from the virus than tested positive—a day that will eventually come for the U.S.

Markets Extend Decline as Stimulus Debate Continues

Editor's Note: The following section was posted Sunday, March 22, 2020.

Last week was certainly difficult, with headlines about rising death rates in Italy, soaring infection rates in New York and major market indexes falling by 15% (the most since 2008) followed by another 3% Monday.  While difficult, underneath those headlines, were some reasons to be optimistic: government accelerated its action to help stabilize individuals, businesses and markets. In addition, we are starting to see the first signs globally that containment efforts work and demonstrating that we can contain the virus is the first step to a global recovery.

While Congress debated and came close to moving forward on an ever-growing stimulus package (as of today, the total was $1.8 trillion), disagreements between Democrats and Republicans pushed likely passage later into the week. The Federal Reserve, however, acted decisively. After previously committing to buying $700 billion in treasury bonds and mortgage-backed securities, Chairman Powell announced they would be buying an unlimited amount of Treasurys, mortgages and corporate bonds (which had fallen by double digits). Market participants are selling less because they are afraid of default (e.g., these high quality companies won’t pay them back) and more because market participants sold these bonds because they needed cash to cover other obligations.

With the Federal Reserve’s actions, we saw high quality corporate bonds jump over 5% in price, which is a very large move for the usually tame corporate bond market. Turning to fiscal policy, we anticipate the stimulus package will pass eventually, which will provide direct assistance to effected big businesses (e.g., airlines, hotels), loans to small businesses through the Small Business Administration (SBA) and directly to individuals, up to $3,000 per family. In addition, Treasury Secretary Mnuchin was out Sunday and today talking about the Fed making up to $4 trillion available in business loans, in an approach similar to what we saw in the financial crisis. Where does all that money come from?

While Minneapolis Fed President Kashkari reminded us that the Fed won’t run out of money because it can also make more, the Fed isn’t allowed to take losses, which means it can’t buy assets that don’t pay. So part of the $1.8 trillion in government stimulus will go to the Treasury, which will in turn guarantee that the Fed gets repaid if the bonds it buys default. That gives the Fed a lot of buying power and gives businesses the loans they need to hopefully make it through this horrible situation. The big question for the markets and the economy is how long this situation will last. How long will Americans and people around the world be asked to stay home and forgo the things we all enjoy—things that also power jobs and the economy? Well, global data gives us some understanding of just how much time it might take to get things back to a “kind of” normal.

Net New Infections as a Key Indicator

We are watching net new infections very closely. Net new infections looks at the day over day change of total number of infections, less deaths and recoveries. At the beginning of the crisis in a new geography, net new infections start slow and then soar exponentially, doubling every day or so. If containment strategies like social distancing work, then the growth in new infections should stall, and eventually decline, until recoveries exceed new infections, at which point net new infections will turn negative. If you look at the net new infection graph below for South Korea you can see this pattern:

Source: WEAS/John Hopkins as of 8:00 AM 3/22/2020

If we look at New York, the epicenter of infection on the East Coast, recent days look a lot like the early days of the outbreak in Korea. While New York is taking longer to get testing ramped up than South Korea, there is reason to be optimistic that if New Yorkers follow social distancing and containment guidelines, we could see the net new confirmed case begin to go negative in two to three weeks. Let’s hope that happens.

Government Acts to Slow the Spread of COVID-19

Editor's Note: the following section was posted March, 23 2020 at 9:30 a.m. CDT.

Across the country we are seeing a variety of new restrictions aimed at helping to contain the spread of COVID-19. While it’s clear that these restrictions will suppress economic activity, we nonetheless applaud the stronger measures to stop the spread of this disease which is putting the lives of millions of Americans at risk. The best thing we can do for the economy is to slow the spread of the disease.

On Wednesday, the State of California issued a shelter-in-place order to 40 million residents. Friday morning, new restrictions were placed on New York in an effort to curb the worst outbreak in the country and later that night, the governor of Pennsylvania ordered all non-life-sustaining businesses closed. Over the weekend, New Jersey, Connecticut, Illinois and others followed, putting similar restrictions in place. Similar tough medicine has been applied in China and Korea with good effect. Italy started their restrictions a bit too late and the situation there has devolved into a true humanitarian crisis, but we are looking for signs that social distancing and other policies will begin to bring down the infection rate.

While these restrictions are disruptive and have generated downright scary headlines, the market appeared to applaud the moves early Friday almost telling investors that this tough medicine is what is needed to cure the patient, our country and economy, before selling off in the late afternoon. Major market indexes in the U.S. (S&P 500 and Dow Jones Industrials) ended down over 4%.

One piece of good news we observed Friday is that markets are responding to the liquidity being injected by the Federal Reserve, allowing those that want to sell risky assets (or even non-risky assets like Treasurys) to do so in an orderly manner. Correlations between asset movements also appeared more normal with high quality bonds rallying as markets declined and higher-risk currencies, like the Euro, rallying and selling off with equity markets. Orderly markets are important because they preserve these correlations which lay at the base of our portfolio construction assumption for achieving effective diversification.

In important news, Democrats and Republicans are working well together to craft stimulus legislation to support the economy through this difficult, but ultimately transitory period. As part of relief efforts, student loan payments can now be suspended for 60 days without interest, the federal tax filing date has been extended to July 15, and the senate is preparing to vote on a stimulus package worth over a trillion dollars.

Provisions being discussed as part of that package include direct payments to adults below certain income levels as well as specific loan guarantees and grants to companies that are struggling because of the crisis. We are very happy to be hearing that there will be an emphasis placed on supporting small business, which is the backbone of the U.S. economy—though how this will be achieved is still unclear. We do believe this will only be the first of at least one to two more packages to help support and restart the economy.

The proposed stimulus is not without controversy; there is a lot of talk about making hand-outs to companies, including those in the airline industry. The same companies who, in hind sight, overpaid executives (their companies wouldn’t be in need of a bail out if they had done the job they should have done) and used profits to buy back stock rather than doing what our clients do—build up a rainy day fund. Bailing out companies after bad behavior creates a moral dilemma; why do the right thing if the government will always be there to bail you out? The 2008 bail-outs and associated legislation around the financial service industry seem to have gotten this roughly correct, as the banks didn’t get themselves into trouble this time and much of the speculative behavior of the early 2000’s seemed to have shifted to hedge funds, whose investors are now bearing that loss and aren’t eligible for government bailouts.

We can expect next week to be similar to the last: more policy announcements, more shelter-in-place orders, more on possible treatments and vaccines, more infections and, most regrettably, more deaths. Don’t let the headlines get you down. As a country and a society, we are now on the path most likely to bring this horrible pandemic to an end. It might take longer than we expect, but we will eventually get through this together.

The Ups and Downs Continue

Editor's Note: the following section was posted March, 20 2020 at 10:00 a.m. CDT.

Yesterday’s major markets closed modestly higher, with the MSCI ACWI, the S&P 500 and the Dow Jones Industrials rising 0.63%, 0.48% and 0.95% respectively, which almost feels like a non-event given the abnormal volatility of the recent weeks. That said, the VIX index, a measure of expected volatility, stayed near an all-time high, indicating more volatility yet to come. Oil prices continued to swing wildly, with spot crude up 24.8% after collapsing yesterday and small-caps stocks climbed by an impressive 6.20% on reports of record levels of insider (e.g., executives) buying. So what does the continued volatility mean? Markets are still unsure of the depth and length of the economic downturn that is likely to coincide with the actions being taken to contain COVID-19. We believe that uncertainty is likely to continue until we begin to see some signs of successful containment in Western Europe and/or the U.S. and until we understand the scope of the government stimulus.

Some Potential Improvements to Watch

We did get some positive news on the coronavirus front yesterday: China reported no new cases of the virus from community spread. We recognized that data reported by China’s state owned media may be suspect, we know that directionally China and its economy appear to have reached the other side of the crisis thanks to measures like social distancing, which are now being put in place across the U.S. and Europe. We have also seen similar positive developments in Korea and Taiwan. Unfortunately, the number of deaths in Italy have surpassed China, topping 3,400, and infections continue to climb. We continue to watch Italy closely as they were slower than Asian countries were on implementing containment measures.

On the treatment front, the administration held a press conference today to discuss the FDA and private industries’ use of already approved medicines to treat COVID-19—some results look promising. Ultimately, a vaccine will be needed and, despite heroic efforts by the scientific community going from identifying sequencing the DNA of the novel coronavirus to human tests in record time, it still might be 12 months before there is a vaccine widely available to the public.

Presidential Action in the Form of Relief for Some

Finally, the president signed into law a COVID-19 relief package that had been approved by Congress earlier in the week, a prelude to a much larger stimulus package (potentially up to $1.2 trillion). The package provides relief to workers who may miss paychecks as a result of the virus; one provision ensures that workers get two weeks of paid sick leave. The substance and size of the next stimulus package is something we are watching closely. Businesses and families need liquidity to financially survive the downturn, and only the government has the resources to provide such a backstop. You may already be thinking about how this will impact the deficit, but the decision makers are viewing the fight against the COVID-19 virus as a global war, and when the world is at war, fiscal responsibility tends to be pushed aside.

If you have questions about how all this impacts you and your financial plan, we encourage you to connect with your financial advisor.

Understanding the Current Bear Market

Editor's Note: the following section was posted March, 19 2020 at 10:00 p.m. CDT.

The speed of price movements across all financial markets, equity, fixed income, currencies, commodities, etc., may be unsettling to some investors. While the continued sell-off is likely to produce anxiety as it conjures up memories of the 2008 Financial Crisis and associated recession is understandable—this sell-off is sharp and a recession is likely—this isn’t 2008. To help you understand why we feel confident this is true, we want to explore bear markets, defined as when markets decline by 20% from their peak. There are 3 types of bear markets:

1. Cyclical Bear Markets

These market declines are associated with the normal fluctuation of the business cycle. The economy gets too hot; therefore, the Fed needs to raise rates to keep prices in line which results in a depressed outlook for economic growth and an associated sell off. Cyclical bear markets average declines of 31% and last, on average, 21 months.

2. Structural Bear Markets 

A structural bear market is caused when a major bubble or imbalance in the economy reverses. The 2008 Financial Crisis was such a bear market. Individuals and business were over-extended on debt, and banks lent to high risk borrowers. These types of bear markets tend to see deeper sell-offs, on average 57% and recovery is longer, on average, 42 months. The reason for the increased depth and time to recover is that even after consumer start to feel comfortable enough to spend more and business want to invest, banks to too impaired to lend, resulting in stagnation as the banks heal.

3. Event-Driven Bear Markets 

These markets declines are caused by the market attempting to price in the impact of a specific event. The declines after the 9/11 attacks represent such a bear market. Event driven bear markets sell-offs tend to be shallower, averaging 29% and rebounds tend to be more rapid, averaging 9 months.

Our current bear market is clearly the event-driven type. The primary events are government imposed containment measures around COVID-19 which is slowing economic activity.  While this is a disturbing health crisis, data from China, Korea and Taiwan, indicates that social distancing along with increased testing will slow the spread of the virus.

Based on reports from public health officials, we can expect the number of new reported cases to continue to increase over the next 30 to 45 days. However, based on what we saw in Asia, we would hope to see new infections decline and recoveries accelerate. We think the administration is likely correct, that the COVID-19 pandemic will be largely behind us by late summer if the world heeds the advice of the medical community.

Moving Beyond COVID-19

Once behind us, government stimulus packages, deferred demand and ultra-low interest rates are likely to fuel a fast recovery in economic activity. However, a developing oil price war is compounding the COVID-19 crisis.  As global oil demand declines as a result of the COVID-19 crisis, Saudi Arabia made the unprecedented decision to increase oil production. At first this might not seem like a big deal, until you remember that the US is the world’s largest oil producer. Over the last two decades the US has invested substantially in building out its energy infrastructure, which means that many banks and investors hold debt-backed energy infrastructure investments. While Saudi Arabia can produce oil for as low as $3 a barrel, the U.S. fracking industry needs oil in the mid-$40s to make money on new wells. The rapid decline in oil prices by more than 50% is raising concerns about the potential of these energy producers to default. We share this concern but believe it is somewhat limited.

Understanding the New Normal

Editor's Note: the following section was posted March, 16, 2020 at 4:10 p.m. CDT.

Market volatility is being driven by a lack of consensus around the same set of facts. On one hand, China, Korea and Taiwan appear to have successfully contained the virus and appear to be in the process of bouncing back economically. On the other hand, Italy and France have essentially closed and the U.S. is in the process of closing down a substantial portion of its economy to contain the spread. The uncertainty is causing markets to swing widely. Today, the President suggested that the virus could continue to impact daily life late into the summer, but hopefully, infection rates will start to decline much sooner. We are watching new infection rates carefully to try to glimpse the turning point in this very human crisis. If we all follow the CDC’s guidelines around social distancing and hygiene, the better of the two scenarios is more likely to play out.

There have been a series of important events that we should review since our last update. Last Friday, the President delivered a press conference in which he stressed a series of public sector-private sector responses to the crisis. The market rallied, as it seemed that the government was “getting its act together,” especially around testing which is critical to stopping the spread of the virus, and economic relief legislation. Over the weekend, however, the mood turned grim as France announced the closing of businesses except for pharmacies and grocery stores and a flood of closure announcements in the U.S. forced the seriousness of the situation to sink into the broader population.

In response, the federal reserve slashed interest rates to almost 0% and announced a series of liquidity injections to help push rates down further and to support normal market operations. While the market has historically greeted such Federal Reserve action positively, markets again declined on Monday. While we believe the Fed has more tools in its belt, the market consensus on Monday was that the fed did all it could do and it wasn’t enough. After all, does it matter how low consumer’s credit card interest is if consumers stay home and eat microwave meals?

This isn’t 2008. In 2008, the market collapsed because the fundamental solvency of banks was in question, which created bank runs and even more solvency issues. A good development out of 2008 was stronger capital requirements on banks. Now, banks need to hold on to more of their own money for every dollar they loan which means they are less likely to fail. This means that unlike in 2008 when we get to the other side of this scare, banks will start lending again – likely pushing the recovery to be faster and stronger. This slowdown, which may even become a recession, is demand-driven – consumers and businesses aren’t spending – this isn’t a financially driven recession like 2008 or the depression of the 1930s, which means that while it might get painful, the recovery is likely to be faster and stronger.

Distracting Headlines, Market Declines and More on COVID 19

Editor’s Note: the following section was posted March 11, 2020 at 8:45 p.m. CST.

Markets continued their sell-off on a confluence of fears about slowing economic growth related to containment measures associated with the COVID-19 outbreak, the deepening Saudi-Russian oil price war and the failure of the government to lay out additional stimulus to offset the effects of either. The “end of the bull market” is the dominant headline as the Dow Jones Industrial Average (DJIA) closed today down 5.86%, putting the index into bear market territory which is defined as a decline of 20% from its previous peak (which occurred on 2/17/2020).

The S&P 500, which is a broader, more representative index of large U.S. companies compared to the 30 stocks on the DJIA, did not enter bear market territory today. That said, it’s worth reviewing the impact of previous bear markets.

Since 1948, the S&P 500 has entered into 13 bear markets that lasted an average of 13 months with average cumulative declines of 25.8%. In other words, if this turns out to be an average bear market, and we’re currently 20% down, then we’ve already taken most of the pain. Despite that, you might hear pundits suggest that the average cumulative drop in bear markets is over 36%, but that includes the Great Depression – nothing suggests that we are headed in that direction.

More severe equity market declines are usually associated with failures within the financial system itself--think the bank runs in 1930 and the collapse of Wall Street giants in 2008. When financial institutions are strong, recessions and bear markets tend to be shallow. Luckily today, the financial system appears sound; banks are well-capitalized and liquidity—though stretched in some markets—continues to be generally plentiful.

Potential Economic Impact of COVID-19

It would now appear that an economic slowdown because of COVID-19 is all but inevitable: The World Health Organization (WHO) classified the situation from an epidemic to pandemic; Italy closed all business except pharmacies and grocery stores; and the NCAA announced it would play the early games of its March Madness tournament without spectators.

Scientists believe the best response to the pandemic (absent a vaccine or viable treatment) is “social distancing” and good hygiene. While we ultimately expect the U.S. and the world to recover from COVID-19, we could still be in the early phases of this outbreak. Health officials have warned that daily numbers of new infections could continue to rise (as they did in early infection countries like China and Korea) before we start to see the benefits of the preventative measures currently being put in place.

We believe that the economic impact of the crisis will be sharp but not long. Our financial system is in a much stronger place relative to 2008 and government action coupled with a sharp spring-back in deferred demand (you might not buy a new car today because of the virus, but you will still eventually need a new car) should mean a quicker rebound. Part of today’s sell-off was related to the fact that the administration has yet to provide details on an anticipated government stimulus package to offset damage done by the virus. We believe that much-needed relief is coming and may be in the form of delayed tax filing dates, mortgage payment relief for home owners, payroll tax cuts and/or special lending programs for small and medium sized businesses, but until it’s announced and passed by Congress, uncertainty may continue to roil markets.

Update on the oil price war.

As we noted in our March 9, 2020 update (see below), Saudi Arabia announced price cuts over the weekend, which sparked a sell-off that triggered circuit breakers and temporarily halted trading. Today, Saudi Arabia followed up the price cuts with increased production, which further depressed energy prices. You might be surprised to learn that the U.S. is the largest oil producer in the world, which means that our stock market and companies suffer when oil prices drop. The U.S. became a major oil producer after major investment in scale fracking, which was financed by equity markets and debt. While banks are strong, we are monitoring credit risk as lower energy prices could result in defaults and weaken the financial system. We don’t see it yet, but we are closely monitoring this area of the market.

The markets and economy haven’t faced a duel threat of declining energy prices and an expanding viral pandemic. The newness and complication of these issues is causing uncertainty, and that uncertainty is what causes volatility. Information is the antidote to uncertainty. So, as we learn more about COVID-19 (mortality rate, infections, etc.), and the market adjusts to new energy price levels, we should see company earnings start to become more predictable and this period of volatility should subside.

Oil price wars bring new source of volatility.

Editor's Note: the following section was posted March 9, 2020 at 5:25 p.m.

Sunday night, futures markets and non-U.S. equity markets were down as they reacted to two developing stories:

  1. Increased fears of the economic damage associated with the coronavirus, and
  2. A surprise oil price cut by Saudi Arabia.

Monday morning, U.S. markets opened sharply lower as Treasurys saw prices rally (and yields drop) to new record levels. The S&P 500’s harsh 7% decline triggered circuit breakers that temporarily halted trading and, despite a mid-day rally markets closed down over 7%. Circuit breakers were built into U.S. equity markets after Black Monday in 1987 and are designed to make markets more orderly in light of increased automated trading.

Why the Big Decline?

Global economic impact: Despite positive news out of China regarding the coronavirus—Sunday was the first day since the crisis began that China didn’t report new cases—the quarantine of 17 million people in northern Italy made the economic impact of the virus real for many market participants. Additionally, as more governments seek to stop the spread of the disease by enforcing “social distancing,” economic costs will continue to add up as social events, conferences, etc., are postponed or canceled.

Oil price wars: On Friday, OPEC met to discuss potential supply cuts to stabilize declining oil prices associated with reduced demand resulting from social distancing policies. Russia refused to comply with such cuts. While it’s not clear why Russia rejected the proposal, the country took similar action in 2015 to drive prices lower to undercut oil production in the U.S. (For context: The U.S. is the world’s number one producer of oil followed by Russia and Saudi Arabia).

The U.S.’s production cost for a barrel of oil is higher than either Russia’s or Saudi Arabia’s, so when oil prices fall, the U.S. slows production and lower-cost countries gain market share. Saudi Arabia responded to Russia’s refusal by slashing its price for oil and pushing prices even lower in an attempt to undercut the Russians and bring them back to the negotiating table. That plan isn’t likely to be successful in the short term; even though Russia needs petrol revenue to support its spending, it doesn’t need as high an oil price as Saudi Arabia to break even because it has a very large sovereign wealth fund designed to with stand these types of downturns in energy prices.

The impact of these two events compound each other. Slower economic growth from the coronavirus plus lower energy prices means lower future expected inflation and crashing bond yields. The 10-year Treasury yield fell to less than 0.5% for the first time ever on Monday. Energy stocks in the U.S. fell nearly 20%, leading stocks substantially lower and piquing fears of a ripple effect through markets as the risk of default by energy companies may undermine confidence more broadly.

What’s next?

No one knows for sure, but the success of virus suppression efforts in China should be seen as good news. While a vaccine may be 12 months away from being widely available, even the mere promise of a vaccine caps the damage that the virus can do. Further, lower energy prices and interest rates, coupled with a likely government stimulus, should bolster consumers’ spending globally and buffer economic growth.

While it feels awful to see so much red on the screens, the underlying issues are resolvable. As during other periods of high volatility, we believe that investors that stay the course are likely to be rewarded over the long term, while those that try to outsmart the markets will not fare so well. For now, stay informed, take care of yourself, and work with your advisor if you have concerns about your situation.

Markets open down again despite stronger than expected jobs report.

Editor's Note: the following section was posted on Friday, March 6, 2020 at 12:00 CST.

This morning, February new Non-Farm Payroll, i.e. the number of jobs created in the U.S., jumped to 273,000 against expectations of 175,000. In a normal market, that jump would be a strong sign to markets that the economy was strong; however, markets opened sharply down today, ostensibly on fears that continued Coronavirus infections would further dampen demand and disrupt global supply chains.

Markets hate uncertainty, and right now, there is still a lot that is uncertain about the Coronavirus since it’s too new to have enough data to understand the bounds of the disruption it may cause. In an information vacuum, markets will fluctuate wildly as investors interpret the same fact pattern with wildly different conclusions. For example, the VIX, a measure of market uncertainty, has risen 249% YTD (from 13% to 48%). The price of oil, a measure of how active the economy will be based on energy usage, is down 28.22% YTD and the index of airline stocks is down 31.79%.

As the situation unfolds, we are starting to see some new data that can start to help us understand how impactful the virus may be both for individuals and the broader economy. Ultimately, no one wants to get sick, but uncertainty about mortality rates has increased the sense of panic around the virus. Harvard and the University of Hong Kong released research today that suggests that the mortality rate may be around 1.4%. While this mortality rate is higher than seasonal flu (0.1%), it is substantially lower than previous reports which put it closer to 4%. In addition, the actual mortality rate of the virus may still be lower for several reasons:

  • The lack of symptoms in mild cases can cause the actual number of infected to be under-reported;
  • Early outbreaks have been in areas with less access to advanced medical care;
  • Deaths from the Coronavirus have been largely concentrated in older people and those with known medical histories of respiratory illness.

 Bottom line is that the fear of the virus is likely to be disruptive to global economic activity over the next quarter or two, but as our knowledge of the virus and data of the economic impact develop, we expect that markets will settle, and business and consumers will start to revert to more normal patterns of buying and selling.

Markets React to Fed Rate Cut

Editor's Note: the following section was posted on March 3, 2020 at 5:30 p.m. CST

Markets rebounded Monday, as global government action to both stop the spread of the virus and blunt the economic impact seemed imminent.  On Tuesday, the markets got what they wanted, a 0.50% cut in the Fed Funds rate, but then turned sharply lower after Federal Reserve Chairman Jerome Powell stated that the virus and measures taken to contain it will “surely weigh on economic activity, both here and abroad, for some time.”

The Chairman is correct. Millions of people and corporations around the globe are foregoing spending and investment at the same time that the global supply chain is being disrupted by precautionary business and factory closures in affected geographies. New cases and continued spread of the virus is almost certain as infected pockets continue to emerge in ever more cities and countries.

While further market volatility is likely, the long term dynamics of economic growth and global prosperity are unlikely to be impacted in the long run by the virus.

On Tuesday, we broadcast a webinar to our clients; here are some of the questions and answers from that broadcast:

Why did the 10-year Treasury yield decline to 1.01% on Wednesday? What does it signal?

Treasury bonds are the highest-quality financial instrument, meaning that investors believe that they will get their money back, without fearing default. When market volatility increases, investors search for safe assets like Treasuries, causing their yields to fall and prices to rise. Further, the impact to both demand and supply will cap inflation for a while. With reduced inflation concerns, investors are willing to accept lower yields, because when inflation is low the future value of money is increased relative to when inflation is high.

Why did the Federal Reserve cut interest rates today?

Rate cuts are supportive to the economy because they reduce the cost of borrowing for both consumers and businesses. Lower interest rates should spark additional spending and investment because the opportunity cost of savings is lower. Historically, the Fed has been successful and sparking spending and reducing the impact of recessions by lowering rates. While we expect the recent cut to be beneficial to economic activity, cheaper access to money may not be sufficient in the short term to offset some of the impacts of the virus on economic decision makers.

What should I do with my portfolio given the virus?

Your portfolio is unique to you and your situation, time horizon and risk tolerance. If none of those have changed, then your strategic allocation (mix to stock and bonds) should not change. That said, when the market experiences periods of sharp volatility, opportunities often arise. Our Investment Management team is reviewing a number of such opportunities and considering changes in weights and mixes of sub-asset classes within portfolios.

Coronavirus Concerns Trigger Technical Correction

Editor's Note: The following section was posted on February 27, 2020 at 6:30 p.m. CST.

The developing story of the Coronavirus (COVID-19) outbreak continues to drive market sentiment. While the headlines are focusing on the continued spread of the virus outside of China, we want to remind you to focus on the long term. Although it can be unnerving, volatility should be expected and our portfolios are designed to persevere over the long term. 

  • Thursday, February 27, 2020 marked the sixth consecutive down day for U.S. equity markets, marking their official entrance into correction territory, defined as a drop of 10% or greater. 
  • The S&P 500 Index dropped 3% in the morning, rallied midday, and closed down 4.42%. The market is now more than 11% off its all-time high set on February 20.

While the market losses this week have been severe, it’s important to keep this within a historical perspective: 

  • Markets have experienced several 10% corrections following the market bottom of 2009, including the last technical correction in the 4th quarter of 2018.
  • The last 40 years of market history from 1980 through 2019 show that despite average intra-year declines of nearly 14%, annual returns for the S&P 500 Index were positive in 30 out of 39 years, and the average annualized return is 11.82%.
  • High-quality fixed income and conservative assets continue to behave in line with expectations as 10-year and 30-year Treasury bond prices have rallied amid this volatility. Bond yields, which move inversely to prices, are at all-time lows with the 10-year at 1.3% and the 30-year at 1.8%. The broad Bloomberg Barclays U.S. Aggregate Bond Index has gained 0.9% since February 20 and is now positive 2.6% in 2020.

While this week’s market decline is significant, and we should expect continued volatility in the short term, remember that markets tend to reward investors who stay invested over the long term. 

We’ll continue to update as new information becomes available.

Editor’s Note: the following section was posted February 26, 2020 at 3:00 p.m. CST.

As the markets continue to sell off in response to ongoing headlines around the novel coronavirus, a.k.a. COVID-19, it’s important to remember that the potential for market volatility is constant. It’s one of the many reasons we build diversified portfolios—you can’t avoid market risk altogether, but you can be better protected in the event of a downside surprise. In what follows, we’ll provide context as to the source of this particular bout of volatility, COVID-19, and why we think you should stay focused on progress toward your long-term goals rather than on short-term market returns.

Markets are down this week as ongoing news of COVID-19 has dominated the news cycle. On Monday, markets were down about 3% after a spike in cases in Iran, Italy and South Korea over the weekend led to fears that novel coronavirus will impair global economic activity. On Tuesday, the CDC warned Americans to be prepared for possible “disruptive measures” to contain COVID-19 in the U.S., which sent another shock wave through the markets. As of the time of this writing, markets were marginally down yet again on Wednesday. However, diversified portfolios largely behaved as expected, as high quality bonds and most fixed income assets rallied, helping to offset the volatility experienced in equities.

It’s important to look at this week in the context of what has been a very robust equity market over the last 12 months. The Federal Reserve and global central bankers have taken a supportive stance, which increased investor optimism while limiting volatility.  In fact, before this sell-off, we had seen roughly six months without a 5% pullback in stocks. 

Viewed from a historical lens, market sell-offs related to similar contagious disease outbreaks have been short-lived. As you can see in Table 1, of the five outbreaks we studied in the last 20 years, only one showed a negative return and, notably, it also was the shortest duration. 

Table 1: Cumulative Market Return during Active Outbreaks

  Dates Duration MSCI ACWI S&P 500


Global alert from CDC issued 3/12/2003, Final travel alert lifted by CDC 7/15/2003

3/12/2003-7/15/2003 4 months 26.6% 25.7%


MERS spreads to Europe 3/1/2014 
New cases down significantly signaling virus is contained 9/1/2014

3/1/2014-9/1/2014 6 months 6.0% 8.8%


CDC teams deployed to Guinea 3/23/2014 WHO lifts "public health emergency" status 3/29/2016

3/23/2014-3/29/2016 24 months 1.1% 14.9%

MERS South Korea

WHO notified by South Korean officials of first case 5/20/2015 South Korea declares end of outbreak after no new cases for 23 days 7/27/2015

5/20/2015-7/27/2015 2 months -2.5% -4.8%


WHO declares Zika a "public health emergency" 2/1/2016 WHO declares end of "public health emergency" 11/18/2016

2/1/2016-11/18/2016 9 months 14.6% 12.0%

Source: WHO, CDC, Bloomberg.

Our Investment Management Team will continue to monitor market movements for enduring trends and proactively make any necessary adjustments to our portfolios. In the meantime, we’d urge you to avoid making any financial decisions based on headlines or day-to-day changes in the market. A well-thought-out financial plan is built to withstand these kinds of fluctuations. If you have questions about your long-term financial strategy, please contact your advisory team.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Jim Cahn

Jim Cahn

Chief Investments and Business Development Officer

Series 7 & 24 Securities Registrations,1 Series 66 Advisory Registration † Jim brings significant financial services experience along with the investment management industry’s best thinking and best practices to his role as Chief Investment Officer of Wealth Enhancement Advisory Services. Throughout his professional career, Jim’s philosophy on investing has centered on providing clients with...Read More