April 3, 2020

Peak Fear?

Coronavirus stocks e1585942234166

The Bottom Line:


The news this week couldn’t get much worse as death forecasts and unemployment forecasts surge.  Markets worldwide have collapsed at the fastest pace in history as the Coronavirus stalks us all.  Domestically, the US Federal Reserve and the US Federal Government have issued record level stimuli and “whatever it takes” open-ended commitments.  Businesses are queuing up at banks for assistance reminiscent of citizens in bread lines during the depression.  Perhaps we have reached peak pessimism.  If we have, according to history, it’s investable.  As such, we have now removed the last of our portfolio hedges.  



The Full Story:


The Tally of Terribles


The Coronavirus attack and our isolation defense have taken their toll.  To date within the US, 245,000 confirmed cases have resulted in 6,000 deaths.  The White House projects that total COVID related deaths within the US could climb as high as 240,000.  Absent antivirals and vaccines, our national stay at home response has shut down large sectors of our economy leading to 10 million unemployment filings within the past three weeks.  Analysts estimate that the US economy could shrink 30% annualized in the second quarter for a loss of $1.4 trillion in US GDP, the largest quarterly drawdown since the Great Depression.  People we know by name have contracted this disease.  Some we know have died.


The Empire Strikes Back


Today, millions of small businesses around the country will apply for payroll subsidies authorized by Congress.  Millions more will utilize SBA disaster loans, apply for tax credits and defer payroll taxes.  Larger firms, states and municipalities will queue up for a $4 trillion loan pool backstopped by the Treasury and administered by the Fed.  Overall, Congress has authorized $2.2 trillion in fiscal assistance to compliment the “unlimited” monetary assistance and zero interest rate policy provided by the Federal Reserve.  Washington views these measures as “mitigation” and has already begun negotiations on another $2 trillion “stimulus” package to rebuild our nation’s infrastructure.  Our national deficits and debt will bloat to levels unseen since WWII, but we are financing them at record low interest rates.


Pessimism Pays


Markets move through distinct phases in and around crisis and recessions.  Rapid recognition of the oncoming health and economic crisis led to the fastest deleveraging in history. The VIX index, which measures options volatility, provides the best visual to communicate the speed and scale of the panicked liquidations:


Picture 1


By this measure, COVID 2020 generated more fear faster than the Global Financial Crisis of 2008.  During that period the VIX peaked on October 24th while the Dow Jones Industrial Average sank to 8,088.  Three months later the Dow closed at 8,077.  Three months after that the Dow closed at 8,076.  Three months after that the Dow closed at 9,093.  Three months after that the Dow closed at 9,972.  In the current COVID crisis, the VIX peaked on March 16th while the Dow sank to 20,116.  We opened today at 21,413.


Once the panic phase passes, reality sets in, market volatility declines and fundamental debates begin.  How bad will the recession be?  How bad will earnings be?  How many bonds will default?  What shape will the recovery be? Will we recover?  During periods of distress, projections hold negative biases.  It’s human nature.  Yet what drives markets higher is NOT whether reality is good or bad.  What drives markets higher is whether reality is better than expectations.  In fact, on average, stocks RISE during recessions:


Picture 2


Clearly, 2008/2009 added an outlier.  I will assert that following the legitimate crisis in 2008, policy mistakes created an echo crisis in the first quarter of 2009 as the banks appeared insolvent.  Had policy makers addressed these concerns adequately in the fourth quarter of 2008, we likely would not have plumbed new lows in the first quarter of 2009.  Nonetheless, the data point remains that, on average, markets climb during recessions as reality exceeds lugubrious expectations.


Just to extend the view here are the returns post-recession:


picture 3


W&A Buys Probabilities:


In the summer of 2019, the combination of restrictive central bank policy and restrictive trade policy led us to hedge out 20% of our equity market exposure amid rising recession risks.  The quick turnabout from the Fed in the fall moved us to reduce our hedged exposure by half, awaiting economic proof that the monetary easing from the Fed had boosted more than markets.  Prior to the coronavirus outbreak, the economic evidence argued for removing our remaining hedge position as trade agreements began boosting real activity.  Then the virus.  As markets cascaded lower, our hedge position grew quickly in size.  Recognizing the peak in the VIX, we halved our hedge position on March 20th. Recognizing the inception of recession, we fully eliminated our equity portfolio hedge within our models on April 1st.


Will the market spike lower from here?  Perhaps.  Bear markets often go through a bottoming process that includes retesting previous lows.  Will the market go higher from here?  Absolutely.  This just depends on your timeframe.  Referring to the charts above of the previous 12 recessions, markets rose 60% of the time during recession, rose 80% of the time one year after recession, and rose 100% of the time three years after recession.  Remember, we invest in probabilities, not possibilities.


Have a great weekend!



David S. Waddell 
CEO, Chief Investment Strategist




SOURCES: St. Louis Fed, A Wealth of Common Sense, Bloomberg
David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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