We experienced one of the worst months ever in the financial markets in March of this year, then saw a furious rebound in April. After surviving this extreme level of market volatility, let us take a moment to address three questions that might be in the minds of investors.
1. What is the current state of the U.S. economy?
The economy fell so dramatically due to the rapid onset of COVID-19 that many of the monthly macroeconomic indicators that analysts usually rely upon are not very useful in this current situation. Conditions are too fluid and changing too quickly to make these traditional indicators very relevant. Because of the need for an index that is faster in responding to a dynamic environment, the New York Federal Reserve recently unveiled a new Weekly Economic Index. According to its website, “The Weekly Economic Index (WEI) provides a signal of the state of the U.S. economy based on data available at a daily or weekly frequency. It represents the common component of ten different daily and weekly series covering consumer behavior, the labor market, and production.#1
The WEI currently reads -11.91%, implying that the quarterly U.S. GDP will be almost 12% below where it was one year ago. This represents a significant reduction in the size of the U.S. economy, even much worse than what we experienced during the Financial Crisis of 2008. We have not yet seen the bottom, so investors should continue to be prudent in not assuming excessive levels of risk at this time.
2. Why is the stock market rising when the economy looks so bleak?
We hear this question a lot from clients.
It is crucial to remember that markets are relatively efficient in discounting all known information about the economy, corporations, consumers, and central bankers. Please notice that I used the word “efficient,” not “infallible.” Sometimes, markets do get it wrong in interpreting information. Also, the flow of information is mostly random, so when we are in a period of high uncertainty — as with the COVID-19 pandemic — market prices can swing violently back and forth until better information is received and processed by market participants. In his latest annual meeting with investors, even famed investor Warren Buffett expressed some frustration. When asked why he did not employ some of Berkshire Hathaway’s $125 billion in cash in Q1, he answered, ““We have not done anything because we don’t see anything that attractive to do.#2
Markets are always looking forward to future expected growth in earnings. Sometimes, markets are overly optimistic about growth prospects and charge excessively high prices for stocks. At other times, markets are overly pessimistic and dump shares to the curb at ridiculously low prices. History tells us that stock markets (orange) usually bottom several months before the business cycle (black) does.
We do not know if we have seen the bottom yet in the stock market, but it is clear that we are still in a bear market until the major indexes can climb above their 200-day moving averages. Prudent risk management is still key to your future success.
3. What economic conditions can we expect in the future?
Predictions vary widely about what shape the economic rally might take. Optimists tend to favor a V-shaped rally in which we recover quickly back to pre-COVID-19 levels. Pessimists will tell you that we are entering another Great Depression and that you should sell your stocks and buy gold as the only safe asset.
We believe that both of these views are flawed. It is evident that people have changed their behavior over the last three months. Social distancing, work from home, elimination of large group meetings, and rolling lockdowns are probably here for the foreseeable future until we can institute universal testing and administer a proven vaccine.
On the other hand, we have seen an unprecedented amount of monetary and fiscal stimulus applied across the globe. The U.S. alone has made almost $10 trillion available to keep households and businesses afloat during the lockdown. Governments made the decision to put the economy on ice until the peak of infections had passed. Let us also remember that the human race has been incredibly successful because of our ability to innovate and adapt to new threats to our survival in a changing environment. There is no reason to assume it will be any different this time. We have survived many such threats to our survival over 250 years of our nation’s history.
The truth is that no one really knows what shape recovery we will see. It is likely that we will see a challenging period for this country for the next 18 to 24 months. The financial markets have rewarded those who take a long-term approach. We believe the best strategy is to adhere to the financial plan that you developed working closely with your financial advisor. Diversification of global assets in your investment portfolio remains a time-tested process in the face of an uncertain future.
If you are feeling anxious or just need some encouragement, please do not hesitate to contact us. You hired us to be here with you every step of the way, and we take our responsibilities to you and your family very seriously.
Thank you for the trust and confidence you have placed in our firm. Please keep your family and friends safe during this pandemic. We aim to thrive, not just survive, this difficult period.