Market Update
In our year end letter, we cautioned that clients should be emotionally prepared for a decline of close to 20%. Due to a risk that was so unexpected that it wasn’t even considered a possibility the market has dropped over 20% for the year. The decline has been caused by the uncertainty created by the coronavirus. A double-digit decline is not uncommon for the S&P 500, even in years of positive returns (see chart below). When we discuss the risk of stocks, we like to remind clients that the market dropped 22% in one day in 1987 and dropped nearly 50% during the 2001-02 period and the 2008-09 period. Therefore, when people create portfolios, we recommend having exposure to fixed income based on their risk/reward profile. Fixed income provides a source of funds to cover upcoming expenses in these periods of extreme drawdowns. Fixed income also provides funds to add to the stock market during a drawdown.
Source: Calamos Investments
This pullback resembles the 2008-09 period in some respects. In 2008, the housing bubble was in the process of bursting. At the beginning, it was unknown how negatively it would impact the overall economy. The government created more uncertainty when it bailed out Bears Sterns (allowing it to be purchased by JP Morgan) but let Lehman Brothers go bankrupt. Adding to the uncertainty, Congress initially rejected the Emergency Stabilization Act of 2008. The day that Congress rejected the bill, the market dropped 7%. Currently, it is unknown how severely and for how long the coronavirus will impact the overall economy. However, the market is looking for a coordinated response. The market wants a response that will give clarity on the health care side, the financial side and a better idea when we can plan to return to normalcy.
The stock market, just like a business owner, wants clarity in order to predict future cash flows. At first, the worry was that the coronavirus was only going to disrupt the global supply chain. Using Apple as a proxy for the overall market, the virus meant that Apple might not be able to supply all the iPhones needed to meet global demand. The next issue was that the mass quarantine in China would decrease demand for the iPhone. As a reminder, Apple generated over $33 billion in iPhone sales in the fourth quarter of 2019. As the virus has spread throughout the world it becomes harder to project both the short- and long-term effects. For Apple, it becomes harder to project how many phones will be sold in the next quarter and the next year. With the current decline, Apple has lost over 300 billion in market cap (that is close to 10 quarters of iPhone sales). Eventually, Apple will have another quarter of $33 billion in iPhone sales. The main question is how long it will take for sales to rebound.
This is where the market is looking at the administration to provide a game plan. The market wants some clarity on how long this virus will probably last. The market wants solutions to provide help for workers who will lose income and businesses who will lose sales. The administration has been slow to roll out a plan that addresses these concerns. Therefore, the markets first instinct is to sell and ask questions later. On March 12th, we continue to see partisan comments from Congress. This lack of action reminds me of the rejection of the Emergency Stabilization Act of 2008 by Congress. Instead of reassuring the market with a plan, it increased the uncertainty. Apple, the US economy and the stock market will survive this and eventually thrive. However, we don’t recommend becoming aggressive buyers of stocks until the administration provides a detailed plan with the support of Congress.
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