The fate of the markets is largely determined by the path of the virus. Unfortunately, there is still a lack of clarity, with forecasts from the scientific community varying considerably. What is clear is that the virus’ growth rate has accelerated sharply, with confirmed cases up more than 150% last week. It is likely to only get worse, but there are expectations the darkest days will end in the coming 4-6 weeks, as warmer weather, growing herd immunity and medical advances bend the infection rate significantly.
- New confirmed infections for China and other early starters such as South Korea and Singapore have slowed dramatically. We look for a bit of an uptick as their quarantines are gradually lifted, but not to the exponential levels seen before.
- The news from phase 2 countries such as Italy, Spain and France has been especially grim, yet it is important to keep things in context. As can be seen from the chart above, even in hardest-struck Italy only one in 619 has been confirmed with the virus and only one in 5,611 has died.
- The United States is a phase 3 country, yet our numbers have already soared to the point we lead the world with over 135,000 confirmed cases. Once again, New York is ground zero. Based on what we are reading, the numbers may double each week for perhaps the next few weeks before they begin to slow.
- Although the infection is spreading rapidly, it does appear that social distancing is working. Due to the aggressive global response, we do not expect nearly the extreme number of fatalities that were forecast early in the outbreak. Over the weekend, Dr. Anthony Fauci lowered his estimate of U.S. fatalities to 100,000 to 200,000, a huge improvement from Dr. Neil Ferguson’s worst-case forecast of 2.2 million U.S. deaths only two weeks ago.
For the markets, last week had the feel of a return trip from a bungee jump. The S&P 500 gained 10.3% for the week, narrowing its loss for the year to 21%. It was the best week for the Dow since 1938.
- We are by no means calling a bottom based on one week’s move for stocks. Bottoming is often more of a process, not a quick 10% bounce. However, it does appear that sellers are becoming exhausted and value hunters are beginning to do some discount shopping.
- Primary propellants for the market move were massive intervention from the Federal Reserve and a huge recovery package from Washington. We are greatly relieved, as the combo should nullify the doomsday economic forecasts that had been circulating.
- On Monday the Federal Reserve announced a $4 trillion expansion of its lending activities. In addition to the announcement that Treasury and mortgage securities are effectively unlimited, three new facilities were announced. The crisis-era Term Asset-Backed Securities Lending Facility will reopen to support consumer and business credit markets. Two new facilities will serve corporate credit markets – one to lend to investment-grade companies and one to buy corporate bonds directly.
- One of the biggest impediments for the stock market receiving a bid has been the sticky bond market. Investors that have tried to sell bonds to raise cash for stock purchases have been stymied due to liquidity issues. However, the Fed’s “QE4/Infinity” operations described above should restore order to the bond market. This greatly reduces the risk of a systemic credit crisis.
- On Tuesday the Dow rocketed 11% (its largest one-day gain since 1933), after the long-awaited announcement of a mammoth $2 trillion recovery package from Washington. This injection amounts to roughly 10% of our annual GDP, and will go a great way towards reducing the economic damage from the quarantine (estimated at 10-30% of GDP). In addition, there is mention of two more phases of stimulus to follow. The bill was passed by the House and signed into law by President Trump on Friday.
- Thursday’s unemployment claims report of 3.28 million claims was a stunner, at over four times the previous record high. As a testament to the improvement in investor psychology, though, the market managed a gain of over 6% for the day. This was the endcap to three huge up days in a row, and in the wake of such a dismal economic report was perhaps the most impressive performance of them all.
- Though the stock market may have gotten a bit ahead of itself, it now seems it has discovered the price that reflects the near-term risks. Its focus is now on the more distant future. However, we are just entering what we believe to be the critical middle innings, and a reliable timeline for the end of the cycle for the virus is still undetermined. In the near term, the fatalities will inevitably rise and the media coverage will be sensationalized. Combine with inevitable profit warnings and this will almost certainly lead to further short-term periods of market angst. As we have repeated, though, panicked selling rarely pays off in the long run.
- There are many individual shares that have become bargains after the sell-off, and we have made some changes in our security mix, but the outlook for the economy and markets is just too hazy for us to have any real appetite for additional increments of equity risk. The best path forward is continued patience. Meanwhile, we have high confidence in the fundamentals of the companies in which we invest – world leaders with sound management, solid balance sheets, predictable cash flows and wide economic moats.