Markets, Economy

Weekly Kickstart (03/23/2020-03/27/2020)

3/23/20 8:00 AM

iStock-626627280.jpgStocks continued lower last week, as the S&P 500 fell by 14.98 percent to 2,304.92. That left the benchmark index down 28.66 percent 2020-to-date, and 31.93 percent below the record close hit just one month ago. The market is often referred to as a “discounting mechanism,” where the prices equities trade at can (arguably) be viewed as an “efficient” representation of all available information, including not just what has already happened but also what could happen. An oversimplified example of this is to describe the prevailing share price of a company as the present value of its expected future cash flows, and if investors believe a company’s cash flows will increase (decrease) then the price they are willing to pay today for those shares should also rise (fall). Normally the way these dynamics play out can vary from company to company but in recent weeks the selling has been relentless and correlations have spiked.

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Moreover, with a max drawdown of 31.93 percent to date, the S&P 500 in 2020 has already experienced its largest peak-to-trough decline since 2008, and the speed with which stocks have reversed from record highs has been even more extreme. This price action suggests that investors are discounting some sort of sudden and substantial drop in cash flows that would be consistent with what is seen during a recession. The likelihood of this kind of economic downturn has surged as the COVID-19 containment efforts have started to ramp up and the resulting disruptive effects of forced business closures and shelter-at-home orders become clearer. As gloomy as this outlook may seem, a few reasons for optimism have also started to appear. From a pure valuation standpoint, for instance, the selloff has been so drastic this month that the S&P 500 in terms of forward P/E has not been this “cheap” since the panic correction at the end of 2018. Only investors with a long time horizon, though, may be willing to step in here, especially since deeper selloffs are still very much a possibility given the high degree of uncertainty that continues to surround the coronavirus outbreak. At the very least volatility could stay elevated in the near-term because the incoming economic reports over the next month will likely be abysmal as they start to reflect the rapid halt in economic activity caused by the recent and expanding efforts to contain the pandemic. Further, incoming infection statistics are also likely to worsen as the nation’s ability to test for COVID-19 improves. Although the kneejerk reaction in the stock market to a rising number of confirmed cases could be negative, the upside of learning that more Americans than previously estimated had the virus is that by definition it means the mortality rate is much lower, ceteris paribus.

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Another positive worth mentioning is that a handful of developments in Washington last week suggest policymakers are finally starting to recognize how significant the economic hit from the coronavirus may be, and that their monetary and fiscal response will therefore be sized appropriately. This will help soften the blow for those Americans hit the hardest by the outbreak, and also speed up the eventual recovery. Of course the rebound, both in the economy and the stock market, may not follow the classic V-shaped pattern we have enjoyed during the past decade, and instead it could be a choppy road ahead until the spread of the coronavirus is under control. Moreover, the key trend the markets will likely be looking for going forward is a flattening out in the daily number of new COVID-19 cases. Until that evidence of the containment efforts working shows up, it may be difficult for the bulls to have any conviction. None of this means there will not be opportunities in the market, especially for consistent 401(k) participants with a long-term outlook. Additional assistance navigating this environment is available by consulting with a professional financial advisor and as always, we are here to help with any questions you may have.

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Sources: Econoday, FactSet, FRBSL

Post author: Charles Couch

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