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Through Volatility and Viruses, We Are Prepared

The markets hit the trading circuit breaker at -7% for the first time since 2008 this morning. The US treasury yield is below 1% at every maturity for the first time ever. If this market is giving you anxiety, you are not alone.

 We know these moments are coming, and yet it is still anxiety-inducing when they arrive. So, let’s talk about what these markets suggest for the economy and let’s talk about what we can do about it.

Although two weeks ago seems like a lifetime away at this point, where was the economy before the market volatility started? In short, the economy looked quite strong. Consider these numbers:

  • ISM indices were both in growth territory (that is, above 50). The manufacturing sector was being affected by global supply chain issues due to Coronavirus, but still posted a 50.1 level for February. The services sector was showing strong growth at 57.3 for February.
  • Unemployment was still at 3.5% (lowest since 1969), we added 273,000 jobs in February, and prior months were revised upward.

If we look at similar indices for Asia, which is in the throes of battle with the Coronavirus, including quarantines and lockdowns, we see that the Coronavirus is taking a toll. Most measures of economic activity are down and in contraction territory. Although China, in particular, is making good progress on containing the spread of the virus, which is the other side of the economic weakness.

It is clear that markets fear a recession is on the horizon as a result of the reduction in economic activity caused by the Coronavirus and global attempts to reduce its spread. We can look to past viral outbreaks as a guide, but, according to most experts, this novel Coronavirus is likely to infect more people than similar viruses that we have seen in the recent past. How far will it spread and how long will it last? Most experts simply do not know. This makes forecasting very challenging, especially given that the best hope for an effective vaccine is a year out at least.

Central bankers and economic policymakers around the world are acting in a coordinated fashion. This will assist economies around the world in getting to containment with as little economic damage as possible.

The Federal Reserve has reduced rates by .5% to a range of 1-1.25%, and it is very likely that we will see another emergency rate cut soon, in addition to cuts that may come out of their March 17 meeting. We expect that the Fed Funds Rate will be back to zero before the end of the year and maybe in the near future. Other central banks have less room to move rates, but will be using other's policy tools at their disposal. Fiscal policy will also come into play. The US Congress and Executive recently passed an $8B spending bill and we believe there is more on the way to contain the virus and support of the economy. We are likely to see increases in fiscal spending packages around the world, as G7 finance ministers recently agreed to coordinated response at their latest meeting. Supranationals are getting involved as well, with World Bank pledging approximately $10B and the IMF $50B. All this to say: Governments and Central Banks recognize the challenges, and they are responding.

In this environment, what should we be doing?

  • First of all, recall that the S&P 500 still has a positive 1-year return, even after today’s sell-off.
  • Recall, too, that these kinds of market events are expected. We stress test every client’s financial plan with this kind of market volatility and some that is significantly worse. If you are a client of Baker Boyer, you are prepared for this.
  • We should take this moment to recognize the important role that bonds play in a portfolio. Last year we all wondered why we should hold bonds that have such a low expected return. We are reminded why we hold bonds during times like this.
  • People will be coming out of the woodwork to say that they predicted this or that they saw it coming. And maybe they did, but these tend to be the same people who have predicted a recession every year for the last ten. Don’t listen to these kinds of people.
  • We should always maintain a balanced portfolio to mitigate the risk of an uncertain future. The risk of being invested in stocks when the market goes down is one risk. But so is not being invested in stocks when the market goes up. The time will come when we will rebalance portfolios, that is, we will sell some of the fixed income that has done well through this period of volatility, and we will buy the stocks that are on sale. We receive interest on bond and dividends on stocks throughout the year. This cash will also be reinvested in stocks. Over time, this kind of rebalancing will improve long-term returns.

The bottom line is that we should not overreact. Overreaction to market volatility has always been a poor strategy. The only people I know of whose investments fared extremely badly during the downturn in 2008-9 were those who chose to sell out of the market. When the market finally began to turn in March 2009, there was nothing that would have suggested a recovery was about to begin. Headlines were dominated by terrible news that recounted that toll of the market downturn and recession.

The bottom line is that we should not overreact. Overreaction to market volatility has always been a poor strategy.

We know the market will be volatile, but we don’t know which of those moves up or down is the beginning of a new sustained market trend. Given what we know of markets over time, they tend to trend upward over time, so attempting to discern when to get out and back in again can be a recipe for permanent loss of capital. Baker Boyer portfolios are built for uncertain markets. We will make changes as needed over time, but know that when markets are down 7%, your portfolio is down less.

As we go through this market volatility together, we will follow developments in the market and economy very closely and we will keep you updated. Please feel free to reach out to any member of your team to talk about your personal financial plan, and strategies for navigating volatility. Stay well and we’ll get through this together.

About the Author

John Cunnison, CFA

John Cunnison, CFA
Vice President
Chief Investment Officer

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