Stocks went on a wild ride once again on Friday ultimately recovering much of Thursday’s record losses. The market on Thursday gave all signs of sheer panic. Investors were selling everything at virtually any price either to get out of the market or to meet cash requirements elsewhere. Valuation didn’t matter. On Friday investors were tentative bargain hunters most of the day, until a sharp rally in the last 30 minutes sent stocks soaring. But this morning it looks like all of Friday’s gains are about to be wiped out as we all see firsthand what closures and quarantine really means.
Let me take you back to 2008 when markets declined over 50% from the top of October 2007 to the bottom in March 2008. The real epicenter, news wise, of that recession was the weekend in mid-September when Lehman Brother collapsed and Merrill Lynch, AIG, and Fannie Mae were bailed out in some fashion by the government. Stocks behaved much as they had done in recent weeks, lurching up or down depending on the news of the day. While the Treasury and the Federal Reserve acted quickly to try and maintain liquidity, it was a tough fight. Bank deposits, at the time, were limited to just $100,000. Soon after the Lehman collapse, the Reserve Fund failed to hold its $1 price. Suddenly money-market funds were iffy. Stocks bottomed a month later in October, rallied a bit, and then retested those lows in November. As time took us further from the epicenter stocks rallied again, only to have one more decline that reached the ultimate bottom in March. However, many stocks hit their actual lows in November.
Right after the Lehman collapse, Congress was asked to pass TARP and a broad stimulus package. It didn’t. Stocks collapsed with the S&P 500 having one of its worst days ever on September 20, finishing at just over 7550. With hindsight, if you bought anything that day, you would have made 30%+ on your money in a year and more than tripled it today.
Now, I will move to today. The same sense of panic exists right now. Obviously the cause is different, but all anyone is talking about at the moment is the coronavirus. By Friday, we knew that most colleges and universities were closing, and that all sports leagues have suspended their seasons. It was, or should have been, inevitable that virtually everything would close down except for essential services by this week. That is exactly what happened over the weekend. Spain went into lockdown. Others will surely follow. Both China and South Korea have demonstrated that a total commitment to lockdown does dramatically slow the virus spread. On the other hand, Italy and Iran give us a roadmap of what happens when you do too little for too long.
Clearly, shutting everything down, even for two weeks, has a cost. Airlines and hotels have to cover high-fixed costs and need high occupancy. While hotels and airlines aren’t being forced to shut down, they are in crisis mode.
In any crisis, survival is paramount. For some companies, the path to the other side, when the virus subsides and normality resumes, is fairly clear. For others it is less obvious. The picture is complicated by all the unknowns and uncertainties. How long are we going to have to remain house bound? When restrictions are lifted, how fast will we allow ourselves to return to normal life? The stock market hates uncertainty. Hence, emotion and panic today are dominating our behavior. Avoiding airline stocks is one thing, watching companies like Procter & Gamble# go down 10% is another. P&G has raised its dividend each year for well over 60 years. It returns about 3% today just in dividend yield. And, if you haven’t noticed, the company is selling a lot of paper towels and toilet paper at the moment. In panic, investors are throwing out the baby with the bath water.
That doesn’t mean I, or anyone else, knows when panic will end. I am not sure what is left to close. Some cities will mandate the closure of restaurants perhaps. Many will shut down temporarily due to lack of customers anyway.
Economic data to date hasn’t yet shown the harsh reality of all the actions of the past few days. But soon there will be a spike in unemployment claims and lots of layoffs, some temporary but some permanent. There will be businesses that simply don’t have the reserves to survive a closure of a month or more. The government has declared a state of emergency, and the Fed is backstopping banks, which are much healthier than they were before the last recession. Most businesses will get through this, and by the summer or fall this will all hopefully be a bad dream.
Stocks are already in bear-market territory. But the sharpest declines are always at the end. Thursday’s rout of about 10% was the second-worst single session on a percentage basis ever. As noted, when the market opens stocks are likely to fall sharply, reversing most, if not all, of Friday’s gains. From then on, after a required 15-minute pause when stocks fall 7% as they almost certainly will, we will have to reassess. Economically, now that most non-essential businesses have set to close or modify their operations, there are not many more steps to be taken. From here, there are four questions.
1. How long will we all be shut in.?
2. How extensive is the virus’ spread going to be?
3. When can life get back to true normal?
4. Which businesses won’t survive?
Just as the government stepped in during 2008 to rescue the banks, every airline isn’t about to fail. Every non-chain restaurant isn’t about to close. The government will have to provide some kind of funding mechanism to allow industries most hurt a pathway to recovery. But we don’t know the details yet. That only adds to the uncertainty.
It appears it is going to take at least a few more days for all the bad news to sink in. The news today actually isn’t that different than what we reasonably knew or expected last Friday. Maybe the pace of closings is hitting home. But who was about to go clothes shopping for a new spring wardrobe today anyway? Now that everything non-essential is closing, what’s left is the waiting. Will the spread of the virus slow? When? The lack of testing in the U.S. complicates the answers, but it is clear from other countries that over the next 2-4 weeks, there should be progress. In the meantime, markets are going to demonstrate the heightened sensitivity of investors. That doesn’t mean they have to go straight down. Amid the economic carnage, there are real bargains right now. Quality bonds yield about 1% or less. The average stock now yields well over 2%, and anyone can construct a portfolio of dividend aristocrats that yield 3% or more. Leading-edge tech companies are going to continue to grow rapidly in the years ahead. Berkshire Hathaway# now trades near book value or even below. Goldman Sachs is almost 20% below book. You don’t have to be a hero and try and guess which airline is going to survive. You can buy today stocks of world class companies at the lowest price in several years.
Valuation matters. It may not matter today, but ultimately it is all that matters. There are stocks even today that should be avoided. Not every company will survive this crisis intact. But most will. In the stock market, which bottoms are often V-shaped, getting to the bottom can be a process just as in 2008-2009 when we saw three bottoms in October, November and March.
I continue to use my 2-day rule as a guide. There can’t be a bottom if we don’t have at least two real good days back-to-back. If you follow that rule, you may miss the first 10% or so of a recovery. But that’s OK for most of us. It is also noteworthy that many of the worst days in market history happened on a Monday after investors had time to work up their negative emotions over a weekend. The crash of ’29 was on a Monday. The worst day ever, a 22% decline in 1987, took place on a Monday.
My guidance remains the same. Nibble a bit if you have the courage. There are true bargains out there, bargains that will be very apparent when you look back 6-12 months from now. But it is hard to blow an all-clear whistle without knowing the cost and extent of the virus’ economic devastation. Don’t even think of diving in head first until we have had two consecutive good days. But with that said, if last Thursday wasn’t the low, it may prove to have been pretty close. Most of the damage economically is upon us right now. Everything is closed. Markets look ahead. Unless you believe everything will still be closed six months from now, brighter days lie ahead. That’s hard to see however, when the eye of the hurricane is directly overhead.
Today, Joel Embiid is 26. Actor Victor Garber is 71.
James M. Meyer, CFA 610-260-2220