Is it different this time?
Given the extreme volatility of financial markets in the past two weeks, I’d like to share my thoughts what is going on. I’ve been doing a great deal of reading and reflecting, and some of the managers we work with have made some very interesting observations which I’m sharing with you in this commentary.
While our offices currently have only a few essential staff members onsite, the rest of us are working remotely and have the systems and technology needed to ensure that our portfolio management and research functions are fully operational.
As we’re all aware, up until February 24, 2020 the stock market – particularly in the U.S. – had paid little attention to the risks from Covid-19. Stocks had hit record highs and were flying high on low interest rates, optimistic views about the economy, reductions in trade tensions, earnings growth and massive money flows into passive index funds. All of that changed dramatically as COVID-19 spread outside of China and businesses everywhere went into shut-down mode with little idea as to when things would start to normalize.
On top of all the virus-related risks, OPEC and Russia decided that now was the time to begin a war for market share in the oil industry. As a result, oil prices collapsed due to decreased demand for oil combined with increased supply due to the breakdown of OPEC. This exacerbated the market selloff.
To quote one of our managers, “stocks effectively take the escalator up and the elevator down!” This time around, the elevator plunged faster and further than ever before by 30%, accelerated by the proliferation of social media and a huge market presence of passive ETF’s which, when sold, result in every company on an index being dragged down.
I do agree that investors should be worried as the shutdown of manufacturing and the reduced level of consumer spending and movement will undoubtedly push the global economy into at least a short and possible severe recession.
Volatility levels as measured by a volatility index known as the VIX is now slightly above where it was at the peak of the financial crisis in 2008. Spikes in volatility of this magnitude have never lasted for long periods of time and often indicate stock market lows.
It’s important to note that the indiscriminate selling we have witnessed has taken most stock groups down at similar rates, even though many companies and industries will experience a much smaller negative impact from the current crisis and, in fact, some stocks and sectors may actually benefit from this situation.
While I cannot say whether stocks have hit a bottom yet, we are definitely in for a few lousy quarters from an economic perspective. In looking at past bear market cycles, stocks do bottom long before the economic data does and the valuations we’re seeing are already similar to those we’ve seen at prior market lows – like we did in 2009.
Over the past several decades, the stock market has endured some very bad news, yet persevered and prospered in subsequent years. One only has to think back to the Russian bond default and the subsequent failure of Long-Term Capital Management in 1998, which nearly brought the entire market to its knees. In 2000, the technology bubble burst followed by the events of 9/11 in 2001. Enron collapsed as well in 2001. In 2008, we had the financial crisis which nearly drove global economies into a full scale depression.
However, including these periods of bad news and volatility, the MSCI World Index rose almost 500% over a 25-year period through the end of 2019.
In past events, investors have frequently overreacted to such dramatic and unexpected news. However, often in such periods of panic selling, company’s stock market prices diverge significantly from the underlying value of the company which tends to be far more stable. Our investment managers focus on the value of the company and try to ignore the extraneous market pressures. Such divergence in market price vs. company value creates buying opportunities in times like these. For example one of our U.S. Equity managers cited a company in their portfolio in which revenues were supposed to grow 10% this year and are now expected to decline 3% due the effects of a COVID-19-induced recession. This stock has fallen 38%, indicating that it is most likely oversold based on its underlying fundamentals. There are many situations similar to this.
With respect to COVID-19, we’ve already seen some positive developments in China, South Korea, Japan and Singapore who have all materially slowed the spread of the virus via various measures. While the impact of the virus on near-term economic conditions will be significant in these countries, we have a glimmer of hope that the negative economic impact will not have a long duration.
In looking at what’s happening in China, key daily indicators of economic activitywere about 70-80% below their 2019 levels immediately after the Lunar New Year. At the current rate of improvement of 5-10% per week, it’s possible that China could regain normal levels of capacity utilization by sometime in April, four months after the onset of COVID-19.
If Europe and North America are able to follow the path of these countries, one can assume that we can expect economic recovery to commence in the 2nd half of 2020. With the incredible amount of stimulus in North America, demand and consumption should also surge in the 2nd half of the year.
Central banks have learned from the mistakes of the past and there are better safeguards (fiscal, social and monetary) in place to protect against financial crises. Governments and central banks globally have been active, using conventional and non-conventional fiscal and monetary policies to ensure functioning financial systems. The global banking system is well capitalized. The world’s largest economies (primarily the U.S. and Europe) do not have any major global imbalances. This means there’s a low likelihood of systematic damage requiring years to work through (e.g., the U.S. consumer housing leverage in 2008).
As bad as it feels, investors will be well served staying invested in fundamentally strong equities over the long term, and viewing this historic financial panic from an opportunistic perspective.
As always, the ability to have a successful investment experience depends almost entirely on staying the course. The ride can be bumpy at times, but you ultimately need to do this in order to reach your long-term goals. In both 2001 and 2008 everyone was saying, “But this time it’s different.” Of course, we’re hearing those same words today. I can confidently say that this time will not be different, and things will recover once there’s some certainty in the situation.
Steven Belchetz, Senior Vice President
MSCI Market Returns from MSCI Barra