Keeping Steady in Unsteady Times

“Dow Rises 1100 Points on Biden Super Tuesday Victory” – March 4, 2020
“Dow Falls 1100 Points on Raised Coronavirus Fears” – March 5, 2020

These headlines are just dumb. To suggest that the value of US corporations would rise by $ 1 Trillion on the narrowing of the field of Democratic Presidential candidates and fall by $ 1 Trillion the following day because traders suddenly remembered that coronavirus was a real thing again is ludicrous. Did “the markets” forget yesterday about a rapidly spreading virus approaching pandemic proportions in over 70 countries that has been, literally, front page news for over a month?

My friend Peter Keefe says, “There are two types of investors: those who have been humbled, and those who are about to be.” Those making definitive pronouncements and predictions are quickly humbled.

Last week’s volatile slide was a repricing based on not only worries about coronavirus morbidity and mortality but the dramatic reactions to its spread. Conferences are being cancelled. Travel is being cancelled. Movie theaters are seeing a decline. Around the world Disney has closed some theme parks and schools in places like China and Milan are closing for weeks if not months. All of this “cocooning” thwarts economic activity.

Moreover, analysts are lowering earnings’ growth estimates for the current year and beyond. Estimates for earnings growth in 2020 was just shy of 9 ½% at the first of the year. Companies are already downwardly revising forecasts and economists and analysts are now saying 5% is a more reasonable target for earnings growth, though I fear even that modest number may be optimistic.

The truth is, for any silliness in the headlines, this week’s wild swings – the Dow up 1300, down 800, up 1000, down 1100 – is the ugly process of repricing. The markets are struggling to find a the price that most accurately reflects what are still a wide variety of possible outcomes to the coronavirus pandemic.

The bond markets have had less volatility than we have seen in the equity markets. Prices have risen steadily bringing US Treasuries yields down to record lows. The US Ten Year Note has traded at a yield of less than 0.7% this morning. The flight to safety in the bond markets has been stunning and is suggestive that the economic situation could get significantly slower.

The Federal Reserve stepped in this week and lowered the Federal Funds rate ½%. Consensus in the markets is that the Fed will cut another ½%, perhaps as early as their next scheduled meeting in two weeks. Chair Jerome Powell repeated in his press conference on Tuesday that the US economy remains strong. The timing of the cut worried Wall Street as it implied that the Fed must know something much worse about conditions than they are willing to share.

As Chair Powell noted, the rate cut will not cure the virus, and will not fix a broken supply chain. The Fed’s action is to avoid tightening of financial conditions and to boost consumer and business confidence in the face of continued disruption. The question is how much economic damage will the virus do – to supply chains, to travel, to disruptions of businesses.

The simple answer is no one knows.

The most dangerous place to be, where one is most likely to make costly mistakes, is being unaware of what one doesn’t know. It is important to remain doggedly disciplined and dispassionate about the application of that discipline.

It is possible that the virus will subside without a substantive impact on US shores, that Chinese industry will restart, that supply chains will refill, and that the impact on global GDP will be relatively slight and transient. In that case, a “snapback” of the markets is likely and could quickly move to new highs.

It is also plausible that businesses in the US will slow, China will go into contraction, and a global recession will ensue. No one knows. We remain defensive – ensuring that our portfolios are built around strong companies with good balance sheets, strong management teams, and reliable earnings flows that are able to endure through adversity.

It is important as an investor to avoid becoming too emotional on big up or down moves. These days will come, but we are confident that over time our research and patience will be rewarded. This current tempest in the markets does not appear to be subsiding soon. We will continue to keep a steady hand on the tiller, and a vigilant watch as we make our way through the storm.