A bull market that lasted more than a decade became a bear market in less than a month.
The coronavirus was the catalyst, but not necessarily the cause. Maybe no one could have seen a pandemic coming, but stocks had reached valuations that suggested Wall Street thought nothing could ever go wrong.
A few weeks later, the prevailing attitude seemed to be that nothing would ever be the same again. At least nothing good. The S&P 500 fell more than 35 per cent from the closing high on February 19th to the low on March 23rd. It lost 20 per cent in the first quarter.
But as the second quarter got going, the mood among traders grew less gloomy as virus infections approached or passed their peaks in hot spots like New York, Italy and Spain.
Risk and uncertainty still abound. But while the short-term outlook – for investments, the economy and our physical and psychological wellbeing – is impossible to predict with assurance, many investment advisers believe they can glimpse a clearer picture the further ahead they look.
"I can't tell you where we're going to be three months from now, but I'm pretty confident about three years from now," said Simeon Hyman, global investment strategist at ProShares.
He foresees the world returning to a semblance of normality by then, with the stock market reflecting a recovery in physical and economic health. That’s why he recommends maintaining a normal, precrisis approach when it comes to managing portfolios, no matter how nerve-racking that might be.
“Ordinary investors should stick to their discipline,” Hyman said. “Don’t sell into this. Sit on your hands. Continue your systematic investing to the extent you can.”
He advised investors to rebalance portfolios to restore whatever preferred allocation they had to stocks and bonds before the bear market set in. For most people, that would mean selling some government bonds, which have risen in value, and buying stocks, which certainly have not.
Matthew Benkendorf, co-manager of the Virtus Vontobel Global Opportunities fund, also advised rebalancing and staying the course, no matter how bumpy the trip might be.
“I wouldn’t take money out of the stock market,” he said, admonishing against “the classic pitfall of capitulation”.
Looking for silver linings in an otherwise dark cloud, Benkendorf identified “some good things about this”. One is that “government is showing up as it needs to show up,” he said. “They got the checkbook out.”
In the US, Congress appropriated $2 trillion in March for the largest economic rescue package ever. The bill included cash payments to individuals, enhanced unemployment benefits and loans to businesses that contain incentives to retain as many workers as possible.
The US Federal Reserve has been doing its part, too. It cut short-term interest rates to close to zero per cent in March, pledged to buy unlimited amounts of treasury bonds and other debt instruments, and offered nearly unlimited credit to banks.
Ordinary investors bought a fair amount of treasury bonds in the first quarter, and almost nothing else. Long-term government bond funds rose 21.9 per cent, according to Morningstar. But the average bond fund overall lost 4.8 per cent, mainly because of plunges in portfolios focusing on riskier issues, such as high-yield and emerging market debt, each of which fell more than 10 per cent.
The average domestic stock fund was off 21.5 per cent in the quarter. Portfolios that concentrate on economically sensitive industrial companies, financial services and energy did worse than most. Healthcare and technology held up better, but no funds in the main sectors made money.
International stock funds dropped 22.1 per cent, with specialists in Latin America, India and Europe performing especially poorly.
It may be hard to tell with the stock market rising or falling several per cent on many days, but Luca Paolini, chief strategist at Pictet Asset Management, thinks Wall Street has reacted sensibly to the virus.
“There’s a feeling that the market is panicking,” he said. “The market is, I’m afraid, behaving quite rationally. There is huge joblessness. The decline we’ve seen, peak to trough, is appropriate. The market is pricing in a realistic scenario for economic growth in the US and globally.”
A dilemma for investors who sold stocks is that if they don’t buy them back until the virus – and an almost certain recession – have been subdued, they might forgo substantial gains.
“You don’t add risk to your portfolio when the economy is positive. You act when it stops deteriorating,” Paolini said. Signs of that would be “positive news flow regarding the virus”, such as a lower infection rate, more testing or the deployment of a test for antibodies to identify people who have recovered from an infection and are therefore likely immune.
At this point, much bad news is priced into stocks, he said, including a 35 per cent drop in dividend payments. He anticipates a 30 per cent decline in earnings per share, which he called “bad, but not catastrophic”.
Analysts have been sprinting to slash their forecasts for economic and corporate performance. Leading indicators tracked by the Organization for Economic Cooperation and Development recorded “the largest drop on record in most major economies” in March, the group said.
Investment banks have continually revised their predictions for declines in second-quarter economic output, with those of Goldman Sachs and Morgan Stanley approaching a 40 per cent annual rate. As for earnings, FactSet Research foresees the companies in the S&P 500 collectively experiencing a 21.7 per cent decline in the second quarter, compared to the same quarter of 2019. Its full-year forecast is for a 9 per cent decline.
Bear markets often unfold slowly because investors are unsure whether a recession is approaching. James Paulsen, chief investment strategist at the Leuthold Group, argues that there is no such uncertainty now – so it's possible that the selling that typically occurs has already happened in this one.
Kristina Hooper, chief global market strategist at Invesco, highlighted two aspects of the crisis with opposite potential impacts that she says have yet to be fully factored into share prices.
“There’s a potential for slightly lower infection rates than had been expected,” she said, a development that was starting to be realised and could help account for the recovery since late March. But, she said, Wall Street has been expecting a sequel to the $2 trillion appropriation, and none has been announced. The absence of one “could be disastrous” for an economic recovery, she warned.
Like Hyman and Benkendorf, Hooper encouraged investors to maintain the same mix of assets they aim for in more placid times. As for tactical moves, she would add exposure to Asian emerging markets, including China.
“Valuations are relatively attractive, and they’re on the other side of the crisis or have made it through relatively unscathed,” she said.
She also likes emerging-market debt and investment-grade corporate bonds, but is wary of high-yield debt and considers Treasury issues overvalued.
By Paolini’s estimate, the battering in stocks left them at levels that could produce long-term returns of about 10 per cent a year. Because treasury bond yields are so low – the US 10-year bond yielded 0.7 per cent at the end of March – and because all that fiscal stimulus and Fed balance sheet expansion could produce inflation, he expects stocks to greatly outperform bonds over the long haul.
Which stocks he would own depends on the shape of the economic recovery. A sharp, V-shaped one should allow cyclical sectors like industrials and energy to outperform, while technology and pharmaceutical companies should do better in a slower recovery.
Paolini also likes emerging markets. But with trade possibly waning in the post-coronavirus world, he favours ones with big domestic economies like China and Indonesia.
Hyman suggested expanding into foreign stocks to increase diversification, and he would reduce the average maturity in bond portfolios to limit risk. Another way to play defence, he said, is to own higher-quality companies with “long track records of growing dividends and stable earnings growth”.
Benkendorf recommends adding exposure to “phenomenal businesses outside the US,” including stocks of Asian technology companies and “high-quality consumer staples companies in Europe that are often better than US companies.”
Whatever tinkering investors do with their portfolios, Benkendorf encourages them not to think too much about the stock market these days.
“You have to practice a fair amount of benign neglect,” he said.
When investors do think about the market, they should think positively.
“You have to be a long-term optimist if you’re an investor,” he said. “It isn’t a game for pessimists, and the optimists ultimately do win. You have to leverage the advantage of time and be patient.” – New York Times 2020