While we are hopefully starting down the path of recovery from one of the worst economic shocks in our nation’s history, we must continue to be cognizant of the growing divergence between the capital markets and the economy.
This week certainly has the potential to be one of the more pivotal ones we have seen in quite some time. Optimism is continuing to grow around the potential to re-open the economy, with many states, including Ohio, laying out a definitive plan to allow businesses to begin a return to normal. Even though they will be operating under significant restrictions, the psychological boost has been enough for investors to start to imagine the “best case scenario” morphing into reality. Whether or not the return to work plays out that way is yet to be seen.
We are getting closer to a fork in the road as we consider how these facts relate to HCM’s investment strategy. One path contains all the things we have been worried about for the past month and a half. An impending recession with unknown severity and duration, corporate earnings that are expected to significantly contract and historic job losses. Down the other path is unlimited funding and the commitment by the Federal Reserve to support markets regardless of how disconnected stock prices get from the actual economy.
On Thursday, March 26th, we got our first glimpse into how the COVID-19 outbreak was starting to affect the economy. There had been anecdotal evidence of industries having to shutter and business demand slowing, but this was the first meaningful reading and would either confirm or deny the fears that had been building for weeks. Mainly, how bad is it going to be and how will the market react? The Wall St. consensus was for around 700k new unemployment claims, which would have been the highest reading since the beginning of the data set in 1967.
There is a popular finance book by Nassim Taleb titled “The Black Swan” that will most likely shoot to the top of Amazon’s best seller list over the next few weeks. The book focuses on the extreme impact of rare and unpredictable outlier events and the effect they can have on all aspects of life, markets included. The cascade of events that have unfolded over the past few weeks have been historic in a way that most would like to forget but all will most certainly remember. What started as a viral outbreak in China has metastasized into an unrelenting avalanche of shocking headlines and unprecedented actions, both in the markets and society. The markets response to this uncertainty has been as swift and disorderly as any time in history.
Back in 1987, right after the infamous “Black Monday” decline (which took the Dow Jones Industrial Average down by 22.6%), the cover of Barron’s featured a suitcase with two frightened eyes of a panicked investor peeking out of its dark recesses and an arm reaching out waving a white flag of surrender. Selling immediately after Black Monday would have been a mistake and buying immediately after would not have yielded any long-term value. The right decision was to “Stand There” and collect the necessary information and make an informed decision.