Capital Markets Update
March 23, 2020
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The team at Schneider Downs Wealth Management hopes this note finds all of our clients, and your extended families and friends, staying safe and healthy as we as a nation navigate this “new normal.” Just like everyone is adjusting to “social distancing” amid the fight against the Coronavirus (aka COVID-19), the financial markets are adjusting, quite rapidly, as well. The swiftness of the adjustment, or “re-rating,” of assets has caused confusion and fear for many investors and market participants, and understandably so. There are dislocations in equity and high yield/junk bond credit markets that are to be expected during times of a market drawdown. However, there are also large movements in what were previously believed to be safe-haven assets like investment-grade corporate bonds and high-quality municipal bonds, causing heartburn for investors as they navigate these difficult times. In many ways what is happening is unique to this drawdown, but with a closer look, we can see pieces of the Dot-Com Bubble and the Great Financial Crisis that we can look to as a potential pathway forward.
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First and foremost, the U.S. economy is likely facing the largest weekly increase in unemployment claims since the Great Depression, with Goldman Sachs estimating a weekly loss of 2,000,000 million jobs.
[1]
This outsized and tragically large estimate of job loss is due to the systematic halt of the U.S. economy by federal, state, and local officials with the aim of “flattening the curve” in the spread of COVID-19. In this aspect, we are in uncharted territory, as the U.S. economy has never been, for all intents and purposes, shut down (not even during the Civil War, World War I, or World War II). This historic sacrifice by our nation will, we hope, be judged fondly by history. In the short-term however, markets are moving and making adjustments to their new realities. It is in these “adjustments” that we find some common notes to the two previous market drawdowns (the Dot-Com Bubble and the Great Financial Crisis). As markets begin to assimilate and digest the unemployment number, the chart above (provided by CNBC and the Bureau of Labor and Statistics) provides hope and guidance that the labor market will heal over time, and that the pace of healing will speed up as fiscal measures are passed to work in conjunction with monetary policy measures.
During the Dot-Com Bubble/Tech-Wreck, defined as the period from March 2000 through September of 2002, the market was forced to confront the reality that enterprises like Pets.com
[2]
and eToys.com,
[3]
which garnered significant capital from private and public investors, were not viable businesses going forward. The excitement of innovation and the new internet frontier has led investors to forget some of the basic blocking and tackling of investing (e.g. quality management and balance sheet, viable business, short to intermediate runway to profitability … some investors continue to learn this lesson the hard way). As investors turned the page to the new millennia, the high valuations of dot-com stalwarts like Pets.Com and eToys.com were met with the difficult market realties/expectations of profitability and quickly folded. The rapid decline of “internet-related” stocks quickly put the stock market into a free fall, as expected growth failed to materialize into realized growth. In that way, there are some similarities between the Dot-Com Bubble/Tech Wreck and the market fall of 2020; elevated valuations that were not backed up by strong cash flows and earnings that eventually ran out of runway. What makes the current economic/market situation similar to the recession that followed the Dot-Com Bubble bursting, is that a black swan/exogenous event occurred during the downdraft. During the Dot-Com Bubble, the terrorists’ attacks on 9/11/2001, and the following war in Afghanistan, were the unpredictable events that exacerbated the downturn. Today, we are facing two such events: (1) the still-unknown fallout of the shutdown of the American economy due to the Coronavirus and (2) the economic war between the Kingdom of Saudi Arabia and the Russian Federation that saw the price of oil drop from $60 to $22 in a matter of weeks.
[4]
Additionally, there are some similarities between the current market drawdown and the Great Financial Crisis (October 2007-March 2009). Both time periods preceding the declines had equity markets that, at the time, seemed invincible. During the Great Financial Crisis, it was leverage in the real estate and financial sector that ultimately proved to be the undoing of markets. As the economy began to slow down and unemployment began to tick up, the combination of little to no equity in residential and commercial real estate assets (high loan-to-value, low equity) led to a wave of defaults that triggered stress throughout the economic ecosystem. As the market progresses through the current drawdown, markets are faced with the leverage amassed by businesses, both large and small, during the eleven-year bull market that followed the Great Financial Crisis. Similar to that event, where investments previously believed to be “safe” came under pressure, investment-grade corporate bonds and high-quality municipal bonds have come under intense selling pressure
[5]
. In some cases the selling pressure is understandable, as questions about whether the investment-grade rating bestowed upon some corporations is still appropriate given the uncertain economic landscape; in other instances, the selling of high-quality municipal bonds
[6]
, where the situation is largely unchanged, indicates more of a temporary market dislocation.
The most significant difference from the Dot-Com Bubble and the Great Financial Crisis that we see today is the rapid response by the U.S. Federal Reserve and global central banks. Wherein the Dot-Com Bubble was mostly felt in the U.S., and the Great Financial Crisis saw disjointed and non-coordinated responses by global central banks, the response to the Coronavirus has been different
[7]
. The U.S. Federal Reserve has been incredibly aggressive in addressing the causes of market turmoil (e.g. reinforcing repo and commercial paper markets, extending SWAP lines, including investment-grade corporate and shorter municipal debt
[8]
as securities available for purchase, reinforcing support for money market funds
[9]
, and taking interest rates to 0%). Compared with the uneven response to the Great Financial Crisis, which saw the Fed work through multiple iterations of a support plan over the course of several months, this response has been much swifter. In addition, the response has been coordinated with other central banks, which during the Great Financial Crisis, did not follow the U.S. Federal Reserve’s lead, and set back non-U.S. markets for much of the past ten years.
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The chart above shows the cumulative return of the S&P 500 (U.S. Large Cap Stocks) through various bull and bear markets over the past 30 years. In the moment, any of these bear markets can feel all encompassing and that there is no light at the end of the tunnel. However, every bear market, for the long-term investor, creates various opportunities to add to risk-based assets at significant discounts to prior prevailing prices. The current drawdown could conceivably move lower, but it is important to acknowledge that bear markets are not permanent; they eventually end, and greener pastures likely await.
The current market environment is going through an extreme demand shock created by the selflessness of U.S. and global citizens’ deliberate sacrifice of short-term economic productivity for long-term health and economic benefits. The U.S. economy will not remain in a neutral state permanently. While looking at current asset values from equities to bonds is a frustrating endeavor, history points to a brighter future. As the chart above indicates, the short-term pain associated with market downturns can be overwhelming. Eschewing the short-term for a long-term view can provide another perspective in the trajectory of equity capital markets.
In the next few days and weeks, global markets will begin to gain clarity on the way forward. If it provides any comfort, just remember that global equity markets began making big moves upward and bond prices began their recovery long before the economic pain of the Great Financial Crisis ended.
Stay safe and stay healthy. If you have any specific questions, please reach out to your advisor.
Very truly yours,
Jason R. Staley, CFA, CAIA®
Investment Relationship Manager/Director of Research & Due Diligence
Schneider Downs Wealth Management Advisors, LP
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Schneider Downs Wealth Management Advisors, LP (SDWMA) is a registered investment adviser with the U.S. Securities and Exchange Commission (SEC). SDWMA provides fee-based investment management services and financial planning services, along with fee-based retirement advisory and consulting services. Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice. Registration with the SEC does not imply any level of skill or training.
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Schneider Downs Wealth Management Advisors, LP
1 PPG Place, Suite 1700
Pittsburgh, PA 15222
412.697.5200
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