We sincerely hope that you and your family members remain safe during this difficult and trying time in our history as a nation. Despite many of the negative headlines we’ve seen this week, we continue to see early signs for optimism in terms of the recovery from the pandemic. I would like to address where we stand on three different levels.
How are the financial markets responding?
Cycles are present everywhere we look in our world. For example, the earth experiences the four seasons of the annual patterns of rebirth in spring, growth in summer, harvest in autumn, and rest in winter. We see a similar pattern occurring in investor sentiment, which normally leads the business cycle. You may remember that we presented this chart in our Weekly Wire on March 16, just as the Volatility Index was at its peak due to heavy selling of equities. Investor sentiment continues to be bearish even as we see signs of a recovery in progress.
The renowned value investor Seth Klarman spoke of the cyclical nature of investor sentiment in a speech given to the MIT Sloan Investment Management Club in October 2007:#1
“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions. Success in the market leads to excess, as bystanders are lured in by observing their friends and neighbors becoming rich, as naysayers are trounced by zealous participants, and as the effects of leverage reinforce early successes. Then, eventually, and perhaps after more time than contrarians would like, the worm turns, the last incremental buyer gets in, the last speculative dollar is borrowed and invested, and someone decides or is forced to sell.
Things quickly work in reverse, as leveraged investors receive margin calls and panicked investors dump their holdings regardless of price. Then, the wisdom of caution is once again evident, as not losing money becomes the watchword of the day. Investors should always keep in mind that the most important metric is not the returns achieved but the returns weighed against the risks incurred. Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.”
How is the economy responding?
At Telarray, we constantly monitor the U.S. Weekly Leading Index (WLI) produced by Economic Cycle Research Institute (ECRI).#2 ECRI claims that the WLI (Green) anticipates turning points in the U.S. economy by two to three quarters. ECRI also produces a U.S. Weekly Coincident Index (Blue) that measures the current state of the economy. The WLI bottomed in early April, yet the U.S. Weekly Coincident Index continued to decline until last week when it, too, started to turn upward. A quick review of this chart helps explain how leading indicators can be improving while current economic conditions may still be in the process of finding a bottom. This data leads ECRI to believe that the recession will be a deep one; however, the rapid rise in the WLI also implies the recovery could be relatively quick.
We believe that to understand what is truly happening in the economy, it is vital to recognize which indicators are considered leading versus those that are coincident or lagging. Focusing on leading indicators helps keep us looking forward while coincident indicators can help provide confirmation of what the leading indicators are already saying. Let us quickly review a couple of leading indicators.
- In a sign of optimism for the recovery in progress, U.S. Census Bureau data on Business Applications in the U.S. are up and are quickly returning to pre-pandemic levels.#3
- Home buying demand is also strong, according to data from Redfin, the online residential real estate platform.#4 A combination of historically low interest rates and low inventory of houses on the market has led to a V-shaped recovery in home buying demand.
How are investors responding?
I am sure that many investors — fortunately, not you, our clients — panicked and went to cash as stocks were selling off earlier this year. Investors should understand that stock markets are usually aleading economic indicator. The S&P 500 Index of Large Cap stocks bottomed on March 23 despite continued signs of a worsening economy. Financial markets rapidly concluded that the number of new cases of COVID-19 was starting to peak, and this information led investors to show confidence that the end was in sight by purchasing risk assets that offered the highest expected return. If those investors who went to cash early in the correction wait until they receive the “All Clear” signal before they decide to get back into the market, they risk losing the opportunity for large gains. As of May 31, the S&P 500 Index had already gained over 37% from the trough on March 23!
Now that we have likely entered the economic recovery stage of this pandemic crisis, it is important for all of us to evaluate where we stand in terms of our own personal financial goals. It is likely for many of us, certain aspects of our situation may have changed. Some factors to review might include the following:
- Personal health and wellness
- Retirement plans and second careers
- Caring for aging parents
- Helping children make better financial decisions
- Leaving a financial legacy for a charity
If you find that your own personal financial picture may have changed due to the coronavirus, we urge you to contact your Advisor. Having a trained professional available on your personal team should give you assurance and comfort that you are not alone. Do not allow unanswered questions or nagging doubts to eat away at your resolve and negatively affect your quality of life.
Please keep your family and friends healthy. Although we at Telarray have already started a return to the office, we are still working on what the new normal will become. We look forward to the opportunity to meet with you again in a safe and operational physical workplace.
3: U.S. Census Bureau, Business Applications for the United States [BUSAPPWNSAUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BUSAPPWNSAUS, June 2, 2020.