A BRIGHTER FUTURE, with Laidlaw, in this episode Richard Calhoun, CEO of Wealth Management at Laidlaw, discusses the recent market volatility with David Garrity, Chief Market Strategist at Laidlaw.
The topics covered are 1) With the market below 20,000 where might it stabilize, 2) How does this market compare with the 2008 melt down, 3) Did getting rid of the “uptick rule” create more downside volatility, 4) How does algorithmic trading effect the volatility, 5) How will government stimulus for individuals and small businesses help, 6) What are the positives that will give investors confidence.
To listen to the replay, click here.
1) Lets start with the most relevant market question at this point, with the market down below 20,000 has it discounted enough of the Corona impact and at what level do you think it might stabilize?
Given the speed with which the COVID-19 Coronavirus (“COVID19”) has spread across the planet and the increasing severity of the response to address it, expectations for economic performance in 2020 are being substantially reduced. For example, St. Louis Fed chief James Bullard said 2Q20 GDP may shrink -50%, with unemployment hitting 30%. Morgan Stanley and Goldman also predict an unprecedented plunge. Morgan Stanley sees a -30% contraction, driving unemployment to 12.8%. Goldman already projected a -24% drop and expects global GDP to fall about -1% this year. Note that we had previously mentioned worst-case scenarios could see a hit to global GDP of as -$2.7 trillion, which would represent a -3.1% decline from the 2019 level of $86.6 trillion.
The main questions investors need to consider at this point are: A.) when will the global spread of COVID19 peak?, B.) how quickly can drugs be found to address COVID19?, and C.) can the infection curve be flattened such that available hospital capacity not be overwhelmed? On the first question, the expectation is the global spread of COVID19 should at some point during 2Q20, but possibly extending to 3Q20. On the second question, nearly 70 drugs and experimental compounds may be effective in treating the coronavirus, a team of researchers reported on Sunday night. The list of drug candidates appeared in a study published on the web site bioRxiv. On the third question, the issue here in the U.S. is whether the “stay-at-home” orders issued in a growing range of states will prove sufficient to slow the spread of COVID19. It appears that a 3- to 4-week hiatus may be the period of time necessary to depress the curve.
The bottom line is the economy bottoms in 3Q20 and begins to recover gradually in 4Q20. Given that the stock market tends to move 6 months ahead of the real economy, this scenario indicates a bottom in 2Q20. A look at the last 2 recessions (2000 – 2002, 2017) shows the S&P 500 bottoms at an average of 13x prior peak earnings and 20x current trough. Assuming markets decide 2020 S&P 500 earnings will decline a not unreasonable -30% this year, that puts the floor on the S&P 500 at 2100, a level that represents a further -9% decline from the Friday 3/20/20 close of 2305.
2) In some comments you made earlier in the week you compared the current situation with the 2008 melt down and said we need to keep to our 2008 playbook, can you discuss what you mean by that?
The situation in 2008 was one where the economic downturn required a fiscal policy response (e.g. TARP, Housing and Economic Recovery Act) in order for a floor to be put under the U.S. economy as it dealt with the dislocations in its financial structure from the sub-prime debt market collapse. While the financial system is now thought to be in relatively better condition, there is a fiscal policy response being developed to address the COVID19 recession.
This is a time-consuming process, something creating uncertainty for investors. While COVID19 is a different sort of shock than that seen in October 2008, markets are waiting on the federal government’s fiscal policy response just as in the 2008 Financial Crisis. It is reminiscent, but not in a good way, of the political maxim of “never let a crisis go to waste” that made the rounds at that time.
The 2008 playbook referred to here for the current stock market is to look at the volatility and valuation levels experienced in the S&P500 during the 2008 Financial Crisis and see how they are unfolding in the present environment. If the S&P500 continues to follow its 2008 trajectory, then US equities may try to hold here for a week or two. The holding pattern in 2008 lasted for 10 trading sessions, from 10/9/2008 (close 910) to 10/23/2008 (close 908). Important to note, however, this period was not the bottom for US stocks in 2008, which only came 20 trading days later (11/20/2008 close 752) and -17% below the 10/23/2008 close.
Above all, it is critical that investors do not believe that any equity market stabilization is a sign of an investable bottom in US stocks since history strongly suggests otherwise and we are mindful that 2020 is running the 2008 Playbook at double/triple time. The next flush down could, in other words, be days rather than weeks away.
3) In that interview you also said traders know the adage “never short a dull market” , there have been several articles regarding the “uptick rule” which was removed in 2007. How much effect do you think that has had on this massive volatility on the downside?
The factors that have created the volatility are the underlying fear and uncertainty associated with the impact of COVID19 on the economy which have led to a number of sessions where there is a dash for cash driving an environment where any asset with a bid is being sold. While the market rules around the uptick are important where are left with the view that it is all just rearranging deck chairs on the Titanic.
4) Do these “Algorithms” that more institutions use to trade exacerbate the downside and should the uptick rule be reinstated, or would it even be effective on these days when the market is halted on limit down?
There would be benefit from putting in place measures that serve to dampen market volatility and given more time for human market participants to sort out the current environment. That said, the last thing I think we should see is some form of an extended market holiday in which the stockmarket would be closed for a number of days. This is an environment where investors need to know that they have the ability to raise funds. Denying the opportunity to have liquidity would only exacerbate panic selling such as we have seen of late.
5) David we have been hearing a lot about actions the Government might take to help individuals and small business owners, which many of our clients are, could you comment on some of those measures and how impactful you think that might be?
The fiscal policy response being crafted may be overly focused on large corporations (e.g. airlines, cruise lines, hotel chains) and not enough on supporting the front-line responders who are addressing COVID19 (e.g. hospitals, specific states). For individual households the prospect of payments totaling $2,000-3,000 will be helpful and should serve to support demand as given the low level of household savings the monies received will very likely be spent.
6) We are obviously in unknown territory here with the Global epidemic, but what do you see as the “positives” that will give investors confidence, help create more stability and opportunities to buy?
Answering the questions spelled out above in Question 1 should serve as guideposts supporting investor confidence and the eventual stockmarket bottoming process that will unfold. Bear in mind, however, that given the likely long-term shifts in consumer and business behavior from the COVID19 pandemic, there are likely certain sectors that will remain depressed for a long time (e.g. cruiselines, commercial real estate). We will be there to help our clients find the opportunities that result.